Both terms – investing and trading – are often used interchangeably by individuals; however, they are two different concepts. While the ultimate goal is profit-making, time is the key factor differentiating investing and trading.
But what exactly is investing, and who is an investor or a trader? Who makes more profit? Should I be a trader or an investor? Let us find out.
Investing can be traditionally defined as investing in asset classes where the goal is to build substantial wealth over a long period. Investors can build elaborate and diversified portfolios of stocks, mutual funds, bonds, and other investment vehicles to accumulate wealth. The benefit from the power of compounding is realised over longer investment horizons, but it sure is one that is worth the wait.
Most investors do not concern themselves with short-term volatility or even bear markets. This is simply because they have a long-term growth vision and expect the markets to bounce back.
Investors also do not commit to frequent buying and selling of assets. This approach can be compared to holding on to equity assets for a very long time and selling only when required. Investors carefully assess their investment options and invest in those securities that are expected to grow in the long term.
Investing often involves thorough research of the company, its strategies, the industry that it operates in, its growth prospects, and more. An aspect here is also to take complete advantage of components like interest, dividends, bonus payouts, etc, to generate passive income and create a corpus for the long term.
Majorly, there are two types of investing – value investing and growth investing.
Value investing is an approach based on analysis of the investment options and finding the stocks of those companies that may be underpriced/undervalued in the market currently. These companies have excellent prospects but may or may not be known well enough– or are not trending in the market for many investors to notice them. That is what keeps the market price capped. Value investors hope that the market will recognize the true potential of these companies in the future, that will then lead to exponential rise in the stock price, thereby churning handsome profits for the investors. This approach has lower risk as compared to growth investing.
Growth investing, on the other hand, involves purchasing stocks with high growth potential in the near-term. It focuses on those stocks that may be trending on the back of some current positive news that may possibly have a longer term effect on its fundamentals, or show a high possibility of revenue growth and above-average earnings. These are stocks that are on a bull run currently. The reason it is riskier than value investing is that market sentiment may change, but more importantly, it may require the investor to invest in high potential yet low-cap or bootstrapped companies that expand and grow rapidly but carry substantial risk.
So, now that you understand investing, let’s take a quick look at what is trading!
Trading is an activity wherein market movements (up and downs) are constantly tracked to make short-term gains. Traders look to capitalise on market fluctuations, aiming to generate profits by continuously buying and selling shares, commodities, currencies, and more.
Traders transact more often than investors. While investors may follow a buy-and-hold strategy, traders generally believe in the opposite. Traders do not carry long-term commitments to the markets. Their strategies are more ambitious and are extremely high risk.
Based on their risk appetite, experience, amount of time available, account size, and several other factors, traders may choose a specific trading style. Let’s read more about it.
Traders, based on their risk tolerance and time horizon, can be classified into several categories. Traders who hold positions for weeks/months are known as position traders. Those who hold them from days to weeks are swing traders. Day traders and scalp traders do not hold their positions overnight – they buy and sell within the day and trade within seconds to minutes, respectively.
Now, traders aim to take advantage of every market movement. This could also be cashing in on falling stock prices through short selling! Selling short is a strategy that involves selling at a higher price to buy back the share/stock at a lower price, difference being the profit.
Let us summarise the difference between investing and trading.
Let us delve deeper into the factors that help us differentiate between investing and trading.
1- Investment approach
While investors carry out a fundamental analysis of a company in question, traders heavily employ technical analysis and tools.
Fundamental analysis is concerned with determining the intrinsic value of a security in view with financial statements and records of a company, the performance and dynamics of the industry (that the company operates in), and the macroeconomic situations of the country. Using these, investors assess the expected growth of the company and arrive at a buy/avoid decision.
However, technical analysis is a different subject altogether. Technical analysis uses historical movement of a stock to determine its future movements. This analysis can be done by employing various tools, charts, and techniques. Line charts, bar charts, ADI, Bollinger Band, MACD, RSI, Fibonacci series, etc, all come under the scope of technical analysis. Remember, technical analysis does not concern itself with the intrinsic value of a stock or its past performance.
Time is a crucial differentiating factor when comparing investing and trading.
Traditionally, investors take ample time to research a stock. And then they also stay invested in the same for years, probably even decades.
But trading is a different activity. Here traders have severe time constraints and need to be on their feet constantly to derive profits. Decisions and even analyses need to be made in a flash of seconds.
Investing as an activity carries lesser risk compared to trading. This is primarily because investing is a long-term activity that does not concern itself with short-term fluctuations. On the other hand, in trading, the risk is constantly high. The buying and selling take place in a week, day, hour, or even a few seconds, and the market dynamics can point anywhere. The risk is high but so is the probability of making huge profits!
Trading is more effort-intensive as compared to investing because one needs to monitor rapidly changing market movements, and all major macro and micro factors. This involves continuous analysis to identify opportunities and changes. Investing, on the other hand, can be considered a passive activity. An investor may not need to track the markets continuously or follow the changing dynamics.
But then, who takes home larger profits? Investor or a trader? Well, it depends on a lot of factors, and also some luck. Let’s decode the dynamics of trading and investing for you with an example.
Assume Mr. X has a capital of Rs. 1 lakh and is a trader. Mr. X employs various tools of technical analysis and finds ABC share that is currently trading at Rs. 8. Mr. X views an upside and trend break at Rs. 15. He further employs other tools to understand the frequency of buying and selling. After finding a good entry point, Mr. X enters the ABC stock at Rs. 8 with his entire capital of Rs. 1 lakh (thus, buying a total of 12,500 shares).
If Mr. X’s prediction is right and the stock does hit Rs. 15 in a week, then Mr. X’s capital swells to ~Rs. 1.87 lakh in a very short period! Now had Mr. X been an investor, and ABC share in 5 years traded at Rs. 100, he would be sitting on a massive profit of Rs. 12.5 lakhs!
But, what happens if instead of zooming to Rs. 15, ABC share falls to Rs.6?
Do you see the factors at play here?
- Risk – Mr. X traded his entire capital at Rs. 8, displaying high-risk tolerance.
- Technical analysis – Mr. X employed tools and techniques from technical analysis. Had his reading gone wrong, his entire corpus would have been eroded.
- Profit – Had Mr. X been an investor here, he would have gained far more than his short-term profit.
- Stock selection – ABC could zoom in the long run only if it carried potential. Not all stocks appreciate in the long run. Certain stocks may remain good to trade while others may be good to invest.
- Had you invested in the Japanese stock market 33 years back, your total returns would have been net zero! Yes, that’s right!
- Many Indian stocks trade below their 2012 (10-year period) values. Strange, isn’t it?
From all the above pointers, do you now understand how profits vary with time, stock selection, approach, and market reading?
Investing and trading are dynamic wealth creation activities. However, different methods work for different people, and you can use a strategy based on your risk, knowledge, and time horizons. Whether you choose to invest or trade, the goal is to grow your wealth. Diligence and care are required to pick the right instruments and make informed decisions. If you are new to the space, it may be a good idea to look for a broker or a financial advisor to help you build a portfolio that will reap the expected results.
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