- Investors take a long view on the market. They may invest in retirement funds, ETFs, bonds, and individual stocks for years or even decades at a time.
- Investors are more likely to ride out short-term losses, and typically incur fewer trading fees over time.
- Traders utilize short-term strategies to “beat the market” and maximize daily, monthly, or quarterly returns.
- Traders often pounce on short-term losses to profit from even minor fluctuations. They may incur more trading fees over time, depending on their broker.
Trading and investing are two terms that, if you’re unfamiliar with the investment world, might sound the same.
What do you do when you invest? You trade stocks – right?
Well, not exactly.
Although you may hear these two terms used interchangeably, trading and investing are not the same. Rather, trading and investing are two different approaches to the same goal: making money in the stock market.
While traders seek quick returns on short-term market fluctuations, investors build portfolios of assets that grow for years (or decades) to come.
What is Investing?
The goal of investing is to build wealth over the long haul – years to decades – by building a well-diversified portfolio. They may divide their portfolio into goals, with each section carrying a varying degree of risk, such as:
- Investing in retirement funds, like 401(k)s or IRAs
- Saving for a down deposit on a house or new car
- Building a college fund for themselves or their children
And, unlike trading, investors don’t sell off positions in their portfolio at the first sign of trouble – even if their portfolio takes a significant hit. Instead, they ride out the downtrends (and maybe even increase their holdings to “buy the dip”) on the hope that prices will rebound even higher on the other side.
At the end of the day, investors, unlike traders, stick to the mantra, “The market will always perform.”
What is Trading?
The goal of trading, on the other hand, is to “beat the market” – and the returns seen in buy-and-hold investing. Instead of buying long positions to hold in their portfolio, traders get in and out of positions as quickly as they can turn a profit.
For example, the S&P 500 has generated roughly 10% returns annually over the last few decades, which is the standard for many investors. But traders may seek 10% in profits every month, compounding their profits significantly.
To do this, traders take advantage of small, short-term price fluctuations – either up or down – and jump on opportunities as they arise. For instance, if political uncertainty in Europe were to raise the price of U.S.-based mining companies for three hours, traders would snap up the stock in minutes – and sell again when it showed signs of trending downward.
And instead of waiting out downturns in the market, they may initiate a stop-loss order to automatically sell their assets if the price falls below a predetermined point.
Investing vs. Trading: 7 Important Differences
Trading and investing are similar in that they involve purchasing securities to capitalize on their price movements. But aside from a desire to make money in the market, trading and investing couldn’t be more different.
As we’ve established, investors tend to hold their positions for years to decades. They may keep these in retirement accounts, college accounts, or a generic investment portfolio with a broker, but they typically don’t sell unless a once-in-a-lifetime opportunity forces their hand.
On the other hand, traders may keep their positions for days, hours, or even minutes. In fact, there are four “styles” of traders, defined by how long they hold their assets:
- Scalp traders hold positions for seconds to minutes, and never overnight
- Day traders maintain their positions for hours, though usually not overnight
- Swing traders keep their assets for days to weeks
- Position traders are the most similar to investors, as they hold positions for months to years
The Cost to Invest
While neither investing nor trading has a standardized set amount to begin, laws do regulate the amount of capital you need to have for trading.
Traders use a broker to facilitate their transactions; and typically, brokers require you to maintain a daily account balance, or margin. The Securities and Exchange Commission (SEC) requires traders who trade four or more times in five days to maintain $25,000 in their margin account in order to trade.
Additionally, many brokers charge flat rate or percentage-based fees on every transaction. As such, traders can rack up charges quickly.
On the other hand, investing typically has no minimum – in fact, with the advent of apps like Robinhood that let you buy fractional shares, you don’t even need to invest the price of a single share anymore.
Depending on the broker, investors usually pay fees on their AUM (assets under management) ranging from free to 1% or more. Some investments, such as mutual funds, may also charge sales load, redemption, account, and/or purchase fees.
Traders and investors also do different types and amounts of research to prepare for their positions.
For instance, traders use technical analysis to determine which assets are worth their trading dollars. Moving averages, stochastic oscillators, and recent news reports can all inform the most lucrative trading setups.
Investors, however, usually focus on the market fundamentals underlying choice investments, such as price-to-earnings ratios, forward-facing guidance, and company history and compositions. Investors may also select worthwhile investments by whether or not they pay dividends or how often they increase their dividends.
Often times, investors and traders employ different vehicles to achieve their goals.
For example, investors tend to select funds and assets they expect to rise in price over longer periods of time. These may include stocks and bonds, as well as baskets of funds such as ETFs and mutual funds. Additionally, high-yield savings and cash accounts like money market accounts or certificates of deposit (CDs) can provide diversification and increased liquidity as shorter-term investments.
On the other hand, traders transact more frequently, and in more ways. For instance, they may jump in and out of stocks, commodities, or currency pairs at a moment’s notice. They may also invest in riskier positions that have expiration dates, such as futures and options, or frequently open short-selling positions.
Investing and trading both come with more risk than a traditional savings account, but that doesn’t make them equals.
As a general rule, the shorter your hold time, the better chance you have of losing your investment. As such, individuals with a low risk tolerance may do better avoiding trading, which carries higher risk than investing.
While investors do face some risk, holding positions for years also gives their investments a chance to regain their losses when – not if – the market fluctuates.
For those who do trade, many advisors recommend limiting your trading dollars to 1% of your capital, or 5% of your total investment fund. Others suggest naming the percentage of your capital that you would be comfortable losing forever, and setting that as your trading cap.
Investors and traders also reap different kinds (and amounts) of rewards based on their trading activities.
On the whole, investors take advantage of compounding, reinvesting profits and dividends, and gradual, long-term appreciation to growth their wealth over time. And while they may occasionally sell off stock to take advantage of short-term fluctuations, they still don’t hold a candle to how often traders transact.
By contrast, traders try to profit by buying and selling assets quickly. They may wait for a particular stock to start rising, or they might open a short position to capitalize on falling stock prices.
The goal for traders is to beat the average 10% annual gains that investors shoot for. A successful trader may see 60% returns in a single year – but an unsuccessful trader may go into the red chasing above-average gains.
The Players Themselves
Of course, one of the biggest differences between traders and investors is the people who drift into either basket. While both activities require patience and emotional discipline, the presentation differs vastly.
Traders are usually people who have the time, energy, and resources devoted to constant market analysis. Successful traders may have an instinctive “feel” for the market, or a lot of prior experience to help guide their decision-making. Many also take advantage of advanced algorithms and technical analysis to trade on the smallest fluctuations.
Investors are usually more patient people who aren’t trying to chase their fortunes now – they’re content with seeking financial prosperity over years. Successful investors know when to buy the dip, sell at a high, and hold their position for the long haul. Some investors trust their gut to guide their process, whereas others may employ a financial advisor to build a well-diversified portfolio.
Is Investing or Trading Better for Your Portfolio?
Trading and investing can both be risky enterprises, and depending on your personality, experience, and computational abilities, what’s right for you may not be right for everyone else.
That said, when it comes to your portfolio, the average person is usually better off investing, rather than trying to time the market or beat the S&P with frequent trading. After all, traders may see great gains – but a single blip in the market can wipe out your success in an instant.
Additionally, traders often increase their inherent risk through leveraging, or borrowing money to buy assets, such as trading on margin and short selling. Not to mention, trading is often a speculative game involving quick decisions, educated guesses, and gambling on a whim.
How to Invest Wisely
If you’re ready to get started invested – or looking for tips to move the money you have invested wisely – Q.ai has your back. Start by:
- Creating an investment plan for buying, selling, and rebalancing your holdings
- Preparing to settle down for the long haul
- Identifying under what circumstances it’s okay to exit a position – and when to buy the dip
- Researching your options to build a well-diversified portfolio that suits your goals
- Considering the benefits of retirement funds first, as tax-advantaged accounts may produce more in gains and tax-related savings than traditional investing
How to Trade Wisely (If You Must)
And for those interested in trading, we’ve also compiled a few tips to help minimize your risk:
- Develop a plan to dictate when you’ll buy and sell positions, such as if a stock rises or falls by a certain percentage
- Stick to your rules even if the market is hot
- Decide how much money you could afford to lose in the market – and call that your trading cap
- Keep in mind that advanced traders are using sophisticated algorithms and even modern supercomputers to trade for margins as small as 0.01% gains – regular day traders may not be able to keep up
- Record your transactions meticulously – and know that short-term gains in the market are taxed up to 37%