Investing vs. Trading: What's the Difference?

Investing vs. Trading: An Overview

Investing and trading are two different methods of attempting to profit in the financial markets. Both investors and traders seek profits through market participation. Investors generally seek larger returns over an extended period through buying and holding. Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a shorter time frame, taking smaller, more frequent profits.

Investing

The goal of investing is to gradually build wealth over an extended period of time. This is done by buying and holding a portfolio of one or more asset classes. This can include stocks, baskets of stocks, mutual funds, bonds, exchange-traded funds (ETFs), and other investment instruments.

Investments are often held for a period of years or even decades, taking advantage of perks like interest, dividends, and stock splits along the way.

While markets inevitably fluctuate, investors typically ride out the downtrends with the expectation that prices will rebound and any losses eventually will be recovered. Investors are generally more concerned with market fundamentals, such as price-to-earnings (P/E) ratios and management forecasts.

Anyone with a 401(k) or an individual retirement account (IRA) is investing, even if they don't track the performance of their holdings on a daily basis. Since the goal is to grow a retirement account over decades, the day-to-day fluctuations of different mutual funds are less important than consistent growth over an extended period.

Investment Styles

Investors generally tend to take one of two types of investment approaches. These styles are noted below:

• Active Investing: Investors who take an active investing approach usually tend to monitor the markets on a regular basis and make changes accordingly. Active investors generally seek out particular investments that try to mimic or outperform the returns of a specific benchmark index.
• Passive Investing: Passive investors follow a buy-and-hold strategy. This type of investor does not make an effort to closely monitor the markets on a daily or even regular basis. The goal of passive investing is to track the returns of the benchmark index.

Time Horizon

Investors generally follow a long-term investment time horizon to achieve their goals. This is usually more than one year as evidenced by the buy-and-hold strategy. The total length of time that an investor takes before they get their money back depends largely on their investment style or strategy and their goals. This means that someone saving for retirement has a longer time horizon than someone who is saving money to put a down payment on a house.

Trading

Trading involves more frequent transactions, such as the buying and selling of stocks, commodities, currency pairs, or other instruments. The goal is to generate returns that outperform buy-and-hold investing. While investors may be content with annual returns of 10% to 15%, traders might seek a 10% return each month.

Trading profits are generated by buying at a lower price and selling at a higher price within a relatively short period of time. The reverse is also true: trading profits can be made by selling at a higher price and buying to cover at a lower price (known as selling short) to profit in falling markets.

While buy-and-hold investors wait out less profitable positions, traders seek to make profits within a specified period of time and often use a protective stop-loss order to close out losing positions at a predetermined price level automatically. Traders often employ technical analysis tools, such as moving averages and stochastic oscillators, to find high-probability trading setups.

Trading Styles

A trader's style refers to the timeframe or holding period in which stocks, commodities, or other trading instruments are bought and sold. Traders generally fall into one of four categories:

• Position Trader: Positions are held from months to years
• Swing Trader: Positions are held from days to weeks
• Day Trader: Positions are held throughout the day only with no overnight positions
• Scalp Trader: Positions are held for seconds to minutes with no overnight positions

Traders often choose their trading style based on account size, amount of time dedicated to trading, level of trading experience, personality, and risk tolerance.

Time Horizon

Unlike investors, traders have a short-term time horizon in mind while executing their trades. That's because traders monitor the markets consistently for changes in asset prices before making their moves. The goal is to take advantage of these ups and downs to maximize profits and minimize losses. A trader's time horizon can be anywhere from a few minutes to several days.

Key Similarities

The goal for investing and trading is the same: to make money. Both investors and traders do this by opening accounts so they can easily buy and sell assets like stocks, bonds, and mutual funds among others.

Both investing and trading come with the possibility of risk and reward. After all, there are no guarantees in life, including the markets. Although the degree varies, every asset comes with the potential for loss the same way they promise big gains.

Key Differences

The length of time that an investor and trader hold their assets diverges. As noted above, investors normally have a longer time horizon in mind. This is typically more than a year. Traders, on the other hand, normally hold onto their assets for short time frames. This can be as little as a few minutes.

The potential for loss is among the key differences between the two. There is a risk of losing your money regardless of whether you hold it for the long term or for a short period of time. However, the risk increases for traders for several reasons.

They tend to hold onto their assets for a shorter time frame and they are also more open to holding a diverse set of assets—those that investors may not necessarily keep in their portfolios. This includes futures and swaps.

Unlike investing, trading requires a great deal of time, effort, understanding of the markets, and research. Many traders are experienced and have a greater sense of how the markets work. While investors may also be experienced, a great many aren't. As such, they may rely on the expertise of financial experts, such as financial advisors.

The Bottom Line

People often confuse investing and trading, using the terms interchangeably. But it's easy to see why because there are some distinct similarities, such as the need to open accounts, deposit money, and buy and sell assets.

But the two are very different. Investors have a much longer time horizon than traders and are usually more risk-averse. Traders usually have a better understanding of how different assets and markets work. Whether you're an investor or trader, you should be aware of the rewards as well as the risks involved.