Let’s assume that Jack, the beanstalk guy, had a brother named, John. Let’s also assume that they’re orphans and they don’t live in a world of fantasy.
One day. the two goofballs traded their cow for a big sack of beans. Jack and John agreed to have an equal share of the beans they received. John traded all of his beans for cash. He planned to buy more cheap beans and sell them at a profit. Jack, on the other hand, planted his beans in their backyard. After a few days, Jack’s beans began to grow into a giant beanstalk and he sowed many new bean plant bearings that he could sell. John is a trader while Jack is an investor.
We can say that investing and trading to generate profits in the financial market are more complicated than that, but you get the idea. The two approaches are grounded on the same basic principle: to own something you feel has less value today and to presume it to have more value in the future.
Investing and trading differ in terms of period, level of experience, platforms, risk, and profit. If you’re seeking to generate income in the financial market, here are some of the key differences between the two strategies you need to know.
What is Investing?
Investing is the act of committing money or capital to a venture (like a business or real estate) with the goal of obtaining an additional profit over an extended period of time. Investors buy and hold a portfolio of stocks, basket of stocks, bonds, mutual funds, and other investment instruments.
Investing is long-term
Investing is a long running strategy that does not attempt to top profit from emerging short-term trends of the financial markets. The goal of is to build wealth gradually from long-term uptrends, like a company’s growth.
A value investor, for example, may buy an undervalued stock and sit on it for years or decades, waiting for its price to meet or exceed the underlying company’s value and taking advantage of the perks like dividends, interest, and stock splits generated in the process.
Investing is an art of building wealth with quality stocks
Investors learn business fundamentals to analyze the stocks they want to invest in. They see themselves as part owners of the companies in which they purchase shares. Investors seek companies with such desirable products and services and good long-term prospects to continue providing the needs of consumers.
Investors create wealth by compounding interest and dividends over the years. Having selected a company with strong fundamentals and competitive advantage, investors expect to benefit as the company grows revenues and earns profits in the future.
How investors eliminate their risks
Investing with a margin of safety leads to increased profit potential and limits downside risk. Value investors seek to eliminate their risks by purchasing only those companies whose stock price is significantly below its intrinsic value, which is determined through fundamental analysis and comparison with competitors.
Another risk management strategy is diversification, wherein an investor diversifies their holdings into different industries, companies, and geographical markets.
What is Trading?
Trading, on the other hand, is the active style of participating in the financial markets. Unlike buy and hold investors trying to profit from long-term uptrends, traders rely on short-term price movements to generate returns from both rising and falling markets.
Trading is short-term
Traders buy and sell securities within a short time period, often holding a position overnight or less than a single trading day.
There are four different trading styles, namely Position (positions are held from months to years), Swing (positions are held from days to weeks), Day (positions are held throughout the day and with no overnight positions), and Scalp (positions are held for seconds to minutes).
Traders choose which trading style is suitable for them based on certain factors including the amount of time that can be spent on trading, account size, level of trading experience, risk tolerance, and overall personality.
Trading is a skill of timing
Trading involves more frequent buying and selling of stock, commodities, forex or currency pairs, and other financial instruments. Unlike traditional investors who seek larger returns over an extended timeframe through buying and holding, traders take advantage of both rising and falling markets when they enter and exit positions over a shorter period of time, taking smaller yet more frequent profits.
While investors employ mostly fundamental analysis tools, traders rely on technical analysis tools to look for high-probability trading setups. Lower commission rates, advances in technology, and the emerging of online brokerage firms have allowed individuals to use these tools and systems which enable them to follow and interpret the market.
How traders eliminate risks
Comparatively, trading involves higher risk as the price might go high or low in a short while. Traders often use a protective stop loss order to automatically exit losing positions.
Sophie Harris is one of the resident writers for FP Markets, a CFD and Forex Trading provider in Australia with over 12 years industry experience serving global clients. Writing informative content about business and finance is her cup of tea.