Trading and investing are often used interchangeably in financial speak. While the two involve exposure to financial markets like the stock market, they are actually different strategies. A few key factors must be considered before choosing whether trading or investing, or a combination of the two, is a better strategy for you.
• Time horizon
The main difference between trading and investing is time. Both involve the buying and selling of financial goods but in general, trading is done over a shorter time period. One can trade assets daily or weekly, sometimes even several times in a day. Investors, on the other hand, have a longer time horizon and employ the buy and hold strategy. Financial markets go through fluctuations daily which is beneficial for traders who want to generate quick returns. As long as the market sees an upward trend, these price movements become insignificant over the long term.
• Risk tolerance
Both trading and investing involve some type and level of risk. That said, how much risk one can endure depends on each person. This could be influenced by a number of things such as a person’s age, financial standing, money goals, and comfort level. An investor who has a higher risk tolerance generally takes a more aggressive approach and is thus suited to actively trading in the forex and cryptocurrency markets, as well as other equities and their derivatives. However, those who are more risk-averse lean towards a conservative strategy. They make long-term investments in instruments that are not as risky like bonds and ETFs.
• Capital and projected income
Trading can be done on a very low amount which is why younger people with a higher risk tolerance favor it. There is also the advantage of leverage or borrowed capital, such as with CFDs. When you trade share CFDs, you buy and sell a contract but not the share itself. Contracts go for a much lower price than the underlying asset which is why this product can be leveraged. Of course, there is a higher risk of loss with leveraged financial products but there is also the possibility for bigger returns. Long-term investments, on the other hand, cannot usually be bought on leverage. The capital you start with dictates your market exposure. So when it is low, your projected income may not be as sizeable either. The advantage of investing long-term, however, comes with generating profits from compounding interest and dividends, which increase as time goes on.
• Day-to-day schedule
Those who don’t have time to constantly monitor markets and make financial decisions accordingly are more suited for long-term investment. On the other hand, trading requires daily tracking which could affect your schedule. The benefit though is that this could give you a regular source of income, which is why some people consider becoming full time traders.
Both trading and investing require skill and knowledge. But given that trading is more of a day-to-day activity, it’s more common to let emotions take over. It’s very important for traders to not let fear or greed affect their decision making because it can lead to very costly or overzealous mistakes. Remaining objective in the face of volatile markets is also applicable to long-term investors. For instance, many mistakenly liquidated their holdings at the start of the pandemic. The stock market has since recovered and even surpassed expectations, which is a missed opportunity for a lot of investors who had to buy back their shares.
Whether trading and investing can be effective or ideal for you ultimately depends on these factors. Learning how to balance these strategies according to your goals can make trading and investing excellent ways to build personal wealth.