Module 1, chapter 2: Trading and investing are two common routes of entering the stock market.
When talking about making money in the stock markets, trading and investing are the two terms that come to the mind of every beginner. Most people use these terms interchangeably or without realising the differences between them.
Trading and investing are different approaches, with their respective pros and cons. In this chapter, we will learn about them.
What is Investing?
Investing is a long-term operation where your main goal is to gain profits and earn money, using investment tools like mutual funds, bonds, baskets of stocks, and more.
Investment entails low risk as compared to trading.
Unlike trading, investing continues for years and decades and offers several perks like capital appreciation and dividends, besides other rewards like stock bonuses and splits. Moreover, in investing, market fluctuation and the risk of downtrends don’t significantly impact your investment.
The reason for this is simple — it is a long-term investment. So, there is always a chance that prices will rise sooner or later if the underlying company is increasing its profit. Therefore, you don’t need to worry about downtrends or recessions with this approach.
Pros and Cons of Investing
- Low risk
- Doesn’t require huge initial investment
- Long investment horizon
- Average returns
- Lower tax liability compared to trading
What is Trading?
Trading offers high returns but also involves higher risk.
Trading is a short-term process that involves frequent transactions according to stock market trends. Unlike investing, you don’t have to stay invested in trading for a very long time. Some common examples of trading tools include stocks, currencies, commodities, and other financial instruments. The main perk offered by trading is higher profit.
For example: With strong trading skills, you can make 3-5 percent profit monthly, which could almost double your capital in a little over a year. However, trading has its downsides, too. It is very dynamic and involves higher risk as compared to investing. The reason is that this process directly depends on market trends. So, it can result in heavy losses as well.
Pros and Cons of Trading
- Easy and convenient
- Attractive returns
- Price discovery
- Higher risk
- High tax liability
- Requires time commitment and understanding of specialised skills
Differences Between Trading and Investing
Now that we have discussed trading and investing, it is time to highlight the factors that set the two approaches apart. Both processes work differently and are suitable for different types of investors.
Here are some major differences that will help you choose the right option for yourself:
- Time frame
Time frame is the biggest difference between trading and investing. With trading, you hold the shares of any company of your choice for a very short time, say a single trading day. Note that traders make the most out of daily market trends and undertake transactions (buying or selling stocks) based on minute price fluctuations.
On the contrary, investors buy shares intending to hold them for as long as possible to generate attractive returns. Investment is always done over a longer period, such as years and decades.
- Risk factor
Both trading and investing depend greatly on market movements and therefore, both are susceptible to a fair share of market-oriented risks.
However, day trading involves higher risk because of the shorter time window that forces traders to quickly make buy or sell decisions.
On the other hand, investing involves very low risk mainly because it’s a long-term affair. In other words, you can hold the stocks until the market turns favourable and then sell them for good returns. The returns might be lower in this case, but it is safer than the dynamic day trading.
Trading requires you to make quick decisions, select every stock carefully, and know how to time the market. Here, your expertise is tested daily, and your profits or losses reflect your decision. Hence, day trading is a dynamic skill you need to possess if you have to succeed with this approach.
On the other hand, investing requires patience and the ability to analyse the market deeply. It involves a slow and steady approach.
You may have heard of traders making more money than investors. However, you should know that Warren Buffett became rich in his 60s by investing. The percentage of returns depends on how well the company performs and market conditions.
Trading provides better returns, on an average of 5-10 percent per month, depending on the market’s volatility. The returns in trading are not certain. The same logic applies to investing as well – there is no guarantee of 20-25 percent returns in the upcoming years.
Trading vs Investing — Which One Should You Choose?
Now comes the most important question — Should I trade or invest? Here is the answer:
Trading and investing are great ways to earn money from the stock market. However, you should select the best option by taking into perspective factors such as your financial goals, knowledge and risk tolerance.
Choose trading if…
- You have time. Trading requires full focus and dedication. It requires traders to make quick decisions by closely monitoring stock prices and other parameters that change within seconds.
- You have high risk tolerance. Sure, trading can reward you with higher returns in less time (say a day), but it also comes with higher risk. If you want to become a trader, you must know how to handle and prevent losses.
- You have good sense, experience and skills. Trading is a skill that you need to develop through research, practice, and patience. If you have all these three, you can think of trading.
Choose investing if…
- You don’t have much time. Investing is the best way to secure your financial health and earn a regular passive income, especially when you don’t have time.
- You have long-term goals. Investment is a great option for long-term financial goals. You can start investing today to reap its benefits in your future years or decades. It’s one of the best solutions for a stress-free retired life.
- You have lower risk tolerance. Investing in mutual funds, bonds, and other tools is safer than stock trading. It is a low-risk investment option that can offer you a way to earn a passive income.
Trading vs Investing: ConclusionThe main differences between trading and investing are the time horizon and risks involved. If you wish to make money from the stock market, then the trading vs investing selection should be based on your financial goals and risk appetite. Whether you choose to become an investor or a day trader, it is very important to do your research and develop skills to survive in the stock market.