Trading and investing: what’s the difference?
Volatile stocks and cryptocurrencies have drawn the attention of many who are new to the world of finance. But are they traders or investors? And which are you? Here are three key differences.
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The terms “trading” and “investing” are used as if they’re interchangeable. Yes, the aim of both is to make a financial gain. But are they really the same thing?
Market volatility – and the prospects of making big money – highlight the differences between trading and investing.
The first point to note is that the difference between trading and investing isn’t really down to what you buy or sell. Investors and traders tend to buy and sell the same things (for example stocks, shares, currencies, bonds and commodities). It’s really all about how and when you buy and sell.
Key difference #1: Time
One key difference is the length of time the investment is held.
Traders take advantage of both rising and falling markets and they tend to “enter” and “exit” positions (that’s the fancy way of saying “buy and sell”) over a shorter period of time. This means they are likely to make smaller but more frequent gains or losses. As mentioned above, traders often like volatile markets because the more movement there is, the more chance there is of riding the market up (or down).
By contrast, investors’ longer horizons make them interested in years, or even decades, rather than traders’ weeks, days, hours or even minutes.
Traders tend to have their eyes glued to their screens, constantly monitoring price movements. Investors don’t typically track short-term price movements, and for long periods may not even know what their holdings are worth.
Veteran investor and billionaire Warren Buffett puts the case for long-term investors like this:
“Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. Buy a stock the way you would buy a house. Understand and like it such that you’d be content to own it in the absence of any market.”
Key difference #2: Strategy
Traders might have a strategy, but it’s likely to be linked to short-term fluctuations in price and may be unrelated either to the intrinsic value of the investment itself, or to any of the traders’ personal goals.
That’s very different from the investor. Most investors – because they’re looking long-term – are going to study factors such as the future growth potential of a company. That is just one example of how they might choose which companies’ shares to buy and hold.
Investors are also more likely to be following a personal plan. What’s the investment for? Is it to pay for a house in a few years’ time? Or is it for retirement? If it’s either of those things, for example, the investor can build a plan around when they’re likely to need the cash. And that’ll influence what they choose to invest in.
Key difference #3: Risk
Whether you’re a trader or investor you face inherent risk. You could lose some or all of your money.
But the risks differ. An investor who buys and holds will typically over time make fewer decisions and transactions than the trader, who is moving frequently in and out of markets. So while the investor’s gains may be less spectacular than the trader’s over certain periods, it is also possible that there will be fewer spectacular losses.
Historic stock market data shows that the longer the period for which you own company shares, the less likely you are to register a loss. Traders, by comparison, don’t have this reassurance, because they don’t hold their assets for long.
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