Often times the terms trading and investing are used interchangeably; but, they don’t actually mean the same thing! This article highlights the differences between the two. So, what is the difference between trading and investing?
Stock Trading refers to the buying and selling of stocks in order to make short term profits. Investing refers to buying and selling stocks in order to grow an account over a long term. Trading focuses more on the share price at the moment and investing focuses more on the overall outlook of a company over time.
What is Stock Trading?
The hustle of wall street and staring at graphs with only seconds to respond are a couple ideas that come up when most people thing about stock trading. Stock trading covers a pretty wide range of behavior though. Trading is generally considered the entry and exit of stock positions in order to gain profits that out perform the market.
The majority of stock trading is based on timing the entry and exit and rely more on technical analysis than fundamental analysis.
Types of Stock Traders Based On Timeline
Everyone has heard of Day Traders but they only make up a portion of the Trading community. There are four main types of traders:
Position Traders – The longer term of traders. They generally hold positions from several months to even years. They are typically looking at longer term charts.
Swing Traders – These generally keep their positions for a matter of days up to several months. They generally take advantage of media events, earnings reports, and technical analysis. Swing traders may not trade daily but are more active than position traders.
Day Traders – Traders in this category never hold positions overnight and usually hold a position for minutes to hours of a single day. These are generally full time traders.
Scalp Traders – These are the most aggressive of traders. They require the fastest connectivity and trading speeds because they only hold positions for a matter of seconds to minutes.
Factors that are used to determine what type of trader a person identifies as are account size, risk tolerance, and the amount of time that can be dedicated for trading.
There are a number of different styles of trading as well. Some trade based on media coverage and company announcements and others trade based on charts alone.
Technical Trading – Using candlestick graphs like the ones pictured above to determine which direction the market will go. Some argue that timing the market based on graphs alone is not actually possible but there are a lot of successful traders that would disagree wholeheartedly. This type of trading is often called Market Timing Trading as well.
Noise Trading – Pays attention to news headlines and reacts to company announcements. This type of trading capitalizes on the overall market overreacting to news events. Traders will see news events and trade the large swings in prices. This trading focuses on the overall market buying on greed and selling on fear.
Momentum Trading – This is generally a mix of the two other types. It uses technical charts to identify trends in price and overall direction of a stock and ride the established wave so to speak. A momentum trader looks for small deviance in price to enter a trade expecting the trade to overall follow an established pattern in price. The example below shows where a momentum trader may enter a trade based on an assumption in direction.
What Is Investing?
As stated earlier, investing is a longer term approach to buying and selling stocks and other securities. It is also generally a more conservative approach since it usually involves studying an equity to determine its fundamental value and then buying the security and holding it for a few years to even decades.
An investor is far more likely to gain steady growth over time and generally not worry about market noise and changes in price. For example in Winter 2018, stocks dropped 20% putting the United States in a small bear market. Some Traders watched as they lost 20% of their portfolio and then backed out of the market with losses.
Investors on the other hand took one of two approaches. They may have bought more shares at lower prices (known as averaging down) to reduce their overall entry price because they consider the stocks to be bargain priced. The other approach is they did nothing. They just let the investment sit because they know that historically when averaged out over many years, the stock market usually performs around 8% growth annually.
Types of Investors
There are different types of investors just like their are different types of traders.
Value Investors – This is the most common type of investor. They focus on fundamental analysis and have a set criteria that they generally use to determine a stock’s value. Often times they are looking for stock prices that are undervalued and present a lot of promise to grow.
Growth Investors – Investors that invest in growth stocks which are classified as stocks that trade very high for their current value because investors believe they will continue to grow at a pace that outperforms the market. They generally have high P/E (price to earnings) ratios and can often be considered overvalued.
Active Vs Passive Investing
Investors that choose an active investing approach generally spend a lot of time analyzing a company’s financial reports, news coverage, press releases and fundamental stats. They will maintain investing in companies that meet their requirements and generally always know what’s happening in a company that they are invested in. If the company falls out of favor with them, they will generally sell their stake and find a more worthy company to invest in.
Passive Investors generally invest in the market long term but they do not want to spend all of their free time pouring over data and reading articles. They will invest their money in a mutual fund, ETF, or index fund and let it sit their for years to come. One great example of passive investing is an IRA or 401K. This type of account is usually made up of a fund and money is placed in it without any management from the investor.
Which is Better: Trading or Investing
Well, this completely depends on you as an investor. There are obviously very successful people on both sides of the coin. Warren Buffett is a billionaire investor that started of value investing and now runs an incredible Investment Firm, Berkshire Hathaway.
John Paulson on the other hand made his fortune trading against the real estate market in 2007 and profited $3.7 billion.
There are success stories on both sides but as far as risk goes, generally you will be taking on much more risk as a trader than as an investor. Investing offers steadier growth backed by the performance history of all major indexes.
Trading can be very lucrative also but requires a lot of discipline. A carefully implemented trading plan can be effective as long as emotion is left behind. Making calculated, risk defined trades seem to work for most successful traders.
I personally consider myself an investor but I will occasionally make trades that are risk defined and usually the trades I make would be considered swing trades or position trades. I consider myself a more active investor though and keep an eye on all of my stock positions. I currently have positions in about 20 different stocks and none of my single holdings makes up more than 5% of my entire portfolio. Balance is key and I believe having a diverse portfolio minimizes risk as well.
What I Use For Investing and Trading
For long term investing, I choose companies that I believe in and that I see potential long term growth in. I also have a subscription to Motley Fool’s Stock Advisor premium service. It’s not cheap but it has provided me with literally thousands of dollars worth of good picks. I would only recommend them though if you have a decent size account to make up for the subscription fee. Read my full Motley Fool Review if you are interested in their stock picks.
For trading, I use Webull. Webull offers commission free trading which is really awesome for someone that is trading frequently and for shorter terms. Webull also has a suite of analysis tools that I think are important for people that are trading such as market indicators and candlestick graphs. It’s free to sign up. To see why I love Webull, check out my comprehensive Webull Review.
Hopefully you found this article helpful and now know the differences between investing and trading. Please leave a comment below on which method you think is the most effective or that you would like to use in your strategy. I’d love to hear from you.