Trading and investing both involve seeking profit in the stock market, but they pursue that goal in different ways.
Traders jump in and out of stocks within weeks, days, even minutes, with the aim of short-term profits. They often focus on a stock’s technical factors rather than a company’s long-term prospects. What matters to traders is which direction the stock will move next and how the trader can profit from that move. Trading has a fancy new name these days – momentum investing.
Investors have a longer-term outlook. They think in terms of years and often hold stocks through the market’s ups and downs.
Quality of stock do not matter to a trader as the holding period is small. However, quality of stock is one of the most important factors to consider for the investor.
Timing - Trading is a method of holding stocks for a short period of time. It could be for a week or more often a day! Trader holds stocks till the short term high performance, whereas, investing is an approach that works on buy and hold principle. Investors invest their money for some years, decades or for even longer period. Short term market fluctuations are insignificant in the long running investing approach.
Capital Growth - Traders look at the price movement of stocks in the market. If the price goes higher, traders may sell the stocks. Simply, trading is skill of timing the market whereas investing is an art of creating wealth by compounding over the years by holding quality stocks in the market.
Risk - Undoubtedly, both trading and investing imply risk on your capital. However, trading comparatively involves higher risk and higher potential returns as the price might go high or low in a short while. Since investing is an art, it takes a while to develop. It involves comparatively lower risk and lower returns in a short run but might deliver higher returns by compounding interests and dividends if held for a longer period of time. Daily market cycles do not affect much on quality stock investments for a longer time.
Which one is better?
Trading is riskier for two reasons:
It involves a lot of speculation — that is, quick decisions, educated guesses and just plain gambles.
It demands minimal (or no) diversification since it's difficult to monitor more than a few trades at the same time. Also, diversification by its "evens-out" nature mitigates both the ups and the downs — and traders want the maximum highs they can get.
Another challenge faced by trading is the tax implications. It's easy to trade stocks with just a couple of clicks, but the tax impact isn't always as clear. Short-term capital gain tax rates are higher than long-term capital gain tax rate – this eats significant portion of the trading returns (if any left after the volatility!).
Trading is best done by hedge funds or computers (algos) with huge processing power. They have the skills and tools to manage the risks involved.
Investing comes with own sets of challenges like asymmetric information, overconfidence, disposition effect.
However, on a long term basis for meeting specific goals, it is prudent to go with investing approach as the volatility is low and easier to execute for a retail investor.
SocInvest focusses on investing – generate wealth through compounding returns over a long period of time. We are looking for consistency of Akshay Kumar in investing vs heroes who only deliver one time blockbusters (let’s not take names .. someone may get offended) or Jai & not Viru (in the Sholay video below)..
A Comic take on a life of Traders (Courtesy: Vikash Mantri)
The story of every trader looking for a life partner . Watch till end.
About the Author
I have over 15 years of experience in venture capital, private equity and investment banking in India and Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in Middle East, to look after investments, M&A and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB) and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.
I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).
I am an Insignificant Investor in the public market and co-founder of SocInvest.