Everyone has heard the terms investing and trading, but the problem is that both the general public and the investment community usually cannot distinguish between these two activities.
Many people think that trading is investing and trading equals profits and high returns. However, this is extremely far from the truth and statistically, it is almost impossible for the average person to “trade” successfully. Trading is about market timing, having an opinion or vision on price movements, and “quick” profits which should follow if the opinion is validated by the market. Trading can also be described as speculating, there is a hope of price gain which might or might not realize depending on the market. In the short term, the market is a “voting machine” while it can be characterized as a “weighing machine” in the long term. The risk of losing the principal, or the money invested, is present for both trading and investing, regardless of the investment period.
Long-term investing has been the most sought after and the most successful tool in building wealth over the last century. Patience and the long-term nature of investing, however, makes it both elusive and difficult for the average investor. Trading, however, has been the most followed and the least successful tool in building wealth. Both include taking position in stocks or other financial and non-financial assets for a period of time. However, it is important to understand that the main difference is usually related to the preceding analysis and the time the position is held in the portfolio.
So, what is the main difference between investing and trading?
Very broadly put, investing is capital allocation in order to generate positive returns with the expectation of profits exceeding the initial investment. Investing is not a “bet” on short-term price fluctuation.
Another difference between „investing “and „trading“ is that investing is a more long-term strategy, while trading can be characterized as moving in and out of positions within months, weeks, days, or even minutes. Trading is mostly for those who seek quick returns in the stock market and ride the so-called “wave” or “trend.” Usually, they are the last ones holding the position and catch the end of a cycle.
According to the “traders” themselves, it is particularly important to understand the market movements and keep up with companies’ latest updates to know where the stock is moving and how to profit from this movement. Usually, the average transaction value for traders is lower since they tend to buy and sell more, if they lose, they aim to lose small and if they win, they usually win small. The biggest issue with trading successfully long/term are the transaction costs which tend to eat away the profitability of position taking.
As mentioned earlier, investing is a more long-term approach to wealth building. Often people invest with a 5-to-10-year time horizon. However, father of value investing, Warren Buffet, has said that the favourite holding period for a quality stock should be forever. There are many quality companies out there that have a long and rich history in growing their businesses and returning a steady increase in value for shareholders. Usually, investors try to keep around 10-20 stocks in their portfolio from different sectors and change out the ones where something fundamental in the company has changed (usually for the negative). Investing is less about market timing and more about business-like analysis. Adding 200 euros every month to your investment account and placing it smartly into the market will show very pleasant returns in 10+ years. Dollar cost averaging has been tremendously successful in wealth building throughout different economic periods.
In conclusion, investment activities are usually more time consuming as any sort of research is cumbersome. It is always easier to follow instinct, guess and buy-sell (trade) things on a hunch as compared to a more boring and calculative approach. As is with everything in life, usually investment (or trading) strategy is quite personal, however, the resulting success is less about personal choice and more about making the right choices.