Trading v/s Investing: What is the difference?

Many beginners are often caught in this dilemma of what should their method of attempting profits in the financial market be based upon; trading or investing? Both the investors and traders generate profit by market participation. As the name suggests, investors invest their money for some years, decades, or for an even longer period and gradually build wealth over a period of time.

The original and conventional meaning of trader was "one engaged in commerce," meaning someone who makes a living by buying things and selling them at a profit. Trading is an approach of holding stocks that encourages holding stocks for a short period of time, a day, or a maximum of a week. A trader is interested to hold stocks only till the short-term trade shows high performance, and profit from its highs or lows, whereas, investing is an approach that works on buy and holds a principle. If you're comfortable with the risks, trading with a portion of your money can be enjoyable and could lead to greater profits than investing.

Investing generally implies a lesser amount of profit ratio than trading, but also few severe losses. Whereas, trading involves carrying out short-term trades to earn huge profits with a higher amount of risk and sometimes greater losses too.

What sets Trading and Investing apart?

Now we shall ascertain the factors that distinguish the traders and investors in brief. These are two altogether different approaches to dealing with the stock market and therefore, they come with their own share of features, benefits, and drawbacks.

Time Factor

Just as we discussed, with day trading, the individual holds the shares of a company for a very short period of time, typically a day as the day traders make the most of the daily trends and they buy and sell to make a profit on the basis of minor price fluctuations in a day. On the other hand, investors buy and hold shares for as long as they are profitable and reap the benefits of various perks like dividends and interest.

Risk Factor

Both trading and investing is mainly dependent on the market conditions. Day trading can reap higher rewards and might also result in unexpected losses. Since Investments are long-term, an investor can hold on to a stock till the market becomes favorable enough to sell it off. The returns can be lower than day trading, but the risk is lowered as well.

Technique

Techniques can be the only controllable factor in this. With day trading, an individual has to be capable of making efficient and profitable decisions, should know how to time the market, and select each stock to trade in. These decisions decide his profitability in the market and would make him suffer huge losses otherwise on a daily basis.

Investors have to be efficient in terms of time, patience and keep a keen eye on the market. Consistent analysis and a slow and steady approach are what investing requires in form of a technique.

Overview of Investing

Investing can let you hold the stock for years and earn throughout the growth of that stock. Since the investors’ financial goal is to build their profits over a long period of time, they are futuristic about their profit predictions. Hence, the day-to-day fluctuations are not important but consistent and long-term growth over an extended period is.

Investing not only lets you reap benefits from the price rise but also lets you enjoy the perks of holding it, namely- dividends, interest, etc. Buy and hold investors are risk-averse, unlike traders. Investments are unbothered by short-term price fluctuations. Investors are more concerned about the market fundamentals, like cost-to-earnings ratio and management forecast.

Risk management in trading and investing is also different. Risk management in investing involves measuring and analyzing the potential threat to your investment in the form of risk. As an investor, you must try to be sure of the methods involved in weighing and possibly mitigating the risk factor so that maximum gains can be yielded from your investment.

Investment risks are wholly dependent on your strategies of investing your money and managing your entry and exit trades. The two main/critical risks you must be able to manage are:

Opportunity risk

Opportunity risk is nothing but the kind of risk you develop after you have tied your money to buy a particular stock. The risk is of losing the opportunity to buy any better stock meanwhile. Essentially, you can miss other opportunities until you trade out of the first trade.

This kind of risk involves balancing trade-offs.

Concentration risk

This kind of risk happens when you put too many eggs in one basket. You may think you’ve found that hot stock that’s going to make you a millionaire, so you invest a huge portion of your principal into that stock. By concentrating so much of your money on one investment, you also concentrate the risks associated with that investment and the possibility of losing it all.

Overview of Trading

Trading implies an idea of buying and selling stocks in a day, commonly known as ‘Intraday Trading’. Trading involves frequent transactions of buying and selling stocks, commodities, or other instruments. Here the trader gets to determine his profit or loss before the market closes for the day. It generally is about buying the stock at a lower price and selling it at a higher price. This can also be done the other way round, which is known as short selling, which lets profit from falling markets.

Risks can cause intra-day traders to often suffer a greater impact than investors due to the amount of risk taken and the unpreparedness. However, you definitely can’t be a trader if you’re afraid of taking risks. While investors profit 10% to 15% annually, traders can even make 10% returns each month.

Every trader needs to be aware of these risks associated with trading:

Slippage risk

Every time you enter or exit a position, your account balance fluctuates by a small amount. In each trade that you execute, you buy at the ask price but sell at the bid price. The ask price is the lowest price available for the stock that you want.

The bid price is the highest price someone is willing to pay for your shares. Unfortunately, the bid price is always less than the ask price, i.e. you have to sell at a lower price than the buying price. Hidden costs associated with every transaction are the focus of this risk factor. However, in such cases, it is advisable for you to reduce your bid/ask spread problems with limit orders. As, the amounts for each trade may at first seem small, but as your trading volume increases, so do the amounts you lose.

Poor execution risk

Poor execution risk can occur when your broker faces difficulty in filling your order, which can be due to various market conditions like poor availability of stock or the absence of other buyers and sellers. Here too, these situations can cause you to sell your stock at a lower price than what you actually expect. Although experts advise you to diminish this problem by using limit orders, you still risk having the stock trade through your limit price and not getting your order filled at all.

Gap risk

This kind of risk comes into play whenever a break in trading occurs. At times, a stock opens at a price significantly higher or lower than its previous closing price, and sometimes a stock trades right through your exit price.

For example, a stock may close at Rs.250 a share today and open tomorrow morning at Rs.200.

If your planned exit price is Rs.240, and you have a stop order in place, your order is likely to be filled at the opening price or worse. Price gaps created in this way occur most often at the open. And although relatively rare, a gap also can occur during the trading day whenever surprising news is reported or trading halts.

Salient Features

For trading as well as investing, the holding size depends on the amount of capital that you can invest. A larger capital does not necessarily mean a larger holding, provided that the investor may choose to retain surplus funds for trading while limiting the size of the holding. (just as advised to avoid certain risks). This is a practical way to deal with risk management, as it gives you sufficient reserves while dealing with the reduction of stock/capital due to a loss.

Diversification is an important and helpful aspect when it comes to backing up your reserves from possible losses. A wide-ranging investment portfolio, of stocks or general capital investment, means that your investment holdings are not tied up or locked to limited options. Alternately, this means that in the event of loss, returns from other holdings or investment channels can help you bear it.

In a nutshell, Traders and Investors are both market players with exact opposite approaches for profit-making. An investor’s preference for investing approach over day trading differs from the traders largely due to his risk appetite, investment horizon, and investment style. It is advised to secure enough techniques for forecasting risk and determining options for risk management, get detailed guidance for investment and trading. This can effectively help the potential investors to more likely grow their funds optimally.