As you learn about the stock market, you might notice there seem to be two different types of players on Wall Street.
One is a bit reserved, makes calculated decisions based on a deep understanding of a business’s fundamentals, and has plenty of patience to wait for the right price. The other is ready to dig through every nook and cranny of the market for an opportunity to pounce and likes to read into stock charts and momentum.
The former is an investor and the latter is a trader. Although the terms are sometimes used interchangeably, there are distinct differences between investing and trading. Understanding those differences is crucial when deciding which you would rather take part in.
Investing vs. Trading Stocks – What’s the Difference Between Them?
The primary difference between investing and trading stocks is the time horizon of the positions taken. Investors are in it for a long period of time, often years, whereas traders may only be in a trade for minutes.
This difference in time horizon has significant implications in terms of risk, reward, market knowledge required, and strategies used. Here’s how investing and trading compare.
Stock Investing in 4 Simple Words: Longer-Term Asset Ownership
As mentioned above, investing is a long-term process. The goal is to buy stocks, exchange-traded funds (ETFs), mutual funds, index funds, and other securities at a low price and hold them while they appreciate, with the goal of selling sometime down the line at a higher price.
Successful investors look into both the past performance and forward-looking prospects of investments prior to diving in. Investing is all about taking a slow and steady approach to achieve your long-term financial goals.
How Investing Works
Investing generally starts with an assessment of yourself. In order to make successful moves in the market, you need to have a detailed understanding of your investment goals and your level of comfort with risk.
Once this understanding is achieved, the investor puts together an investment strategy. Strictly adhering to a quality investment strategy will keep emotions that could devastate your returns out of the equation. A quality strategy includes the following:
- Criteria for Buying & Selling Stocks. Whether you plan on taking a growth, value, or income approach to the stock market, your strategy should outline specific criteria for when it’s time to buy and sell shares of stock.
- Diversification. Diversification is the process of spreading your investment dollars across a wide range of stocks and bonds to protect yourself from market fluctuations. If a single stock or group of stocks in your portfolio starts to take a dive, other assets in the portfolio will limit the losses you experience.
- Asset Allocation. Asset allocation plays an integral role in a well-balanced investment portfolio. By spreading your nest egg between different asset classes, such as equities and fixed-income investments, you’ll protect yourself from market volatility, which is one of the biggest risks posed to investors.
Using their investment strategies, complete with parameters telling them what and when to buy and sell, investors analyze the stock market for opportunities.
For the investor, fundamental analysis is key.
Fundamental analysis includes researching a company’s financial standing, future prospects, management, and other key data to determine its fitness as an investment. This analysis can tell an investor whether the company — and therefore its stock — is likely to grow in the future, or if its dividends are sustainable and worthy of investment.
If investors believe the value of the asset will grow in the long run or that its dividends are strong enough to warrant an investment, they snap up shares and wait for the eventual profits to set in. When a stock falls out of line with the strategy, the investor sells the shares and looks for the next opportunity, whether the trade proved to be a winner or a loser.
Pros of Long-Term Stock Investing
Investing is the most common form of market activity among beginners and experts alike. This tried-and-true method for building wealth has become so popular because it offers many advantages. The most important of these include:
- Building Wealth. The stock market has an uncanny ability to help investors build wealth over time. Small, frequent investments can lead to long-term financial stability with the power of compounding returns,.
- Ownership. Investors focus on the long-term ownership of assets. When you buy shares of stock, you actually own a piece of the companies you invest in. This entitles you to a share of profits and gives you voting rights on important aspects of corporate growth.
- Income. According to FINRA, nearly 84% of S&P 500-listed companies pay dividends. With such a large portion of stocks offering dividends to their investors, income is a major benefit for those interested in holding long-term investments.
- The Feel-Good Effect. Investors can choose which companies they will support with their investment dollars. As an investor, you can support companies developing cures for some of the world’s most debilitating conditions, taking aim at social injustice, or working to address climate change. Your investment dollars have the potential to make changes for good.
Cons of Long-Term Stock Investing
Although there are plenty of benefits to being an investor, there are also a few drawbacks to consider when comparing investing to trading. Those include:
- Potential Losses. Investing is viewed as the lower-risk way to access the market. Although the risks aren’t quite as high as they are with trading, investors still take on risk and could lose capital.
- Slower Growth. Long-term investing is centered around slow and steady growth. If you’re looking for quick short-term gains, trading may be the better option for you.
- Research Required. Solid investment decisions require plenty of research. If you’re not willing to put the time into researching the current state and future prospects of a company or fund, investing may not be your strong suit.
Trading Stocks: Short-Term Profits From Fluctuating Prices
Trading is arguably the more exciting option of the two. Unlike investing, traders aren’t making long-term decisions with their money. Their goal is to jump into stocks when the opportunity for significant gains is ripe, and get out — ideally with a profit — once the opportunity has passed.
Trading is a short-term process, and although it comes with the potential for higher returns than investing, there are also bigger risks that should be considered before diving in.
How Trading Works
There are several different styles of trading. Swing traders look to exploit volatility by jumping in while the market is swinging up or down. Day traders never hold a position for longer than a single trading session, and general stock traders may hold a stock for days or weeks.
Whether you’re talking about swing trading, day trading, or another form of stock trading, the goal is the same: make as much money with as short a holding period as possible.
Trading in the financial markets starts with a trading strategy designed to guide when to buy stocks and when to sell them. The trader then uses stock screeners adjusted to their strategy to find opportunities in the market that fit.
Once an opportunity is identified, the trader looks to exploit fluctuations in the stock’s price. Traders use a process known as technical analysis, following price movements on stock charts closely, looking for technical indicators that act as signals to buy or sell stock.
Considering the technical analysis required and the risks involved in trading, this is not the best path to stock market gains for beginners. Successful traders have a detailed understanding of the inner workings of the stock market and are willing to take on significant risk in search of large potential rewards.
Pros of Short-Term Stock Trading
Countless stock traders have made exploiting fluctuations in the market their full-time job. For those who are good at it, trading comes with compelling perks. Some of the most important include:
- Higher Returns. Successful traders earn returns far in excess of average market returns. Due to the high-risk, fast-paced nature of stock trading, it’s not uncommon for professional traders to consistently beat widely accepted benchmarks.
- Excitement. Many find the fast-paced nature of stock trading exciting. Traders are constantly looking for the next best opportunity in the market. So there’s never a dull moment.
- Trade Full Time. If you get good at trading, making a full-time livable wage from it is possible. At this stage, traders are able to quit their day jobs and make their own hours, limited to open market hours of course.
Cons of Short-Term Stock Trading
Sure, there are plenty of reasons to consider trading stocks. However, as with anything else in the world of finance, stock trading comes with drawbacks to consider as well. Some of the most important include:
- Significant Downside Potential. If there’s anything you get from this section of this article, it should be that trading stocks is risky. Traders look for high levels of volatility, which equate to larger opportunities. However, volatility means that the stock experiences sharp movements both upward and downward. As such, chasing short-term opportunities in high-volatility situations is often a recipe for serious declines.
- Gains Taxed at a Higher Rate. Long-term investors have the benefit of taking advantage of the lower long-term capital gains tax rate. Short-term traders must pay their standard income tax rate on gains generated in the market, which is often substantially higher.
- No 100% Accurate Method. Price fluctuations are, by nature, unpredictable. Making trades over a short period of time will ultimately result in a loss from time to time. There’s no 100% accurate method for determining where a stock price is heading. If there was, everyone would be rolling in stock market riches.
Investing vs. Trading Stocks: Which Is Better for You?
There are multiple key differences between investing and trading, and determining which is better for you largely depends on a few factors:
Factor #1: Your Risk Tolerance
Although there will always be a certain level of risk associated with making an investment, there’s far less risk for long-term investors than there is for short-term traders. If you’re not very comfortable with risk, investing is the best option for you to access the stock market.
On the other hand, if you’re comfortable living on the wild side and your interest is primarily in taking chances to achieve the highest level of gains possible, trading may just be your cup of tea.
Factor #2: Technical or Fundamental?
Many people lack the patience to pore through a company’s earnings reports. Those who like to research new things are best fit for investing because the process requires quite a bit of fundamental research to understand the opportunities in front of you.
The most successful investors research opportunities for a minimum of several days, learning everything they can about the company they want to invest in before buying.
On the other hand, if you’re more into fast-paced concepts and a knowledge of the inner workings of things, trading might be more your style. Fast-paced technical analysis gives you the ability to look into the stock market in a way investors simply don’t, making the process exciting to many.
Factor #3: Experience
The most successful traders have a detailed understanding of how the market works and the technical indicators that help predict where the market is headed. Their experience in the market has led to a level of comfort with risk beginners just don’t tend to have.
On the other hand, investing can be done successfully by anyone who’s willing to take the time to research solid opportunities. As such, it’s a perfect vehicle for beginners to enter the market.
Although investing and trading both take place in the stock market, they are two very different animals. If you’re a beginner, even if trading seems like a good fit, take the time to practice investing and get an understanding of how the market works before taking the risks associated with trading.
However, if you’ve had some experience in the market and are comfortable with your technical analysis and research capabilities, trading might just be your opportunity to expand your gains.