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The Difference Between Investing and Trading

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Investing and trading are two different types of strategies those with money and access to financial markets employ. Generally, investing seeks to create slow and steady returns through investing in the future of companies. The trader, on the other hand, seeks to make risky short-term plays in markets, often entering and exiting a stock position in seconds. Both have benefits and risks. It is important to understand each strategy when seeking to buy and sell stocks in the stock market.

Investing

When you invest in a stock, you are picking the stock for a variety of reasons, and typically plan to hold the stock for a long period of time. When you buy a company’s stock, you buy into the company’s values, management team, and fundamentals. Does the company have a trustworthy, experienced executive board? Can the stock continue its high revenue growth for the next 10 years? Is the company’s product or service a sustainable one? Will the company maintain a dominant industry presence? These are questions that an investor must answer.

Investing tends to generate slow, but consistent returns. Each year, you can hope to gain anywhere from 5-10%. It must be stressed, however, that the investor will not tend to care about these numbers. As long as their portfolio features a diversified basket of stocks, each of which has good potential in the long run, the portfolio will trend upwards with the market.

Average return on stocks in 20 years

You may think that a 5-10% return is not very good. However, assuming you reinvest your returns, you can make quite a bit in the stock market over long periods of time. Suppose you make a consistent 7% return each year in an investment portfolio and continue to reinvest your returns. On an initial $10,000, you would end up with $38,696.84, or nearly 4x your initial investment. Suppose you continually add a portion of your income to your investment portfolio, these returns would be magnified even more.

Trading

You have likely heard of the day trader. The day trader often sits in front of multiple computer monitors, screening multiple stocks, options, and other investments, and making thousands of trades in one day. You may have heard of something called technical analysis. This is the main strategy employed by the day trader, where 1-day charts are analyzed for patterns. Technical signals such as the SMA (simple moving average), MACD (moving average convergence/divergence), and RSI (relative strength index) are just a few of the indicators used to trade stocks.

A technical analysis of a stock

Day traders are able to make small returns by entering and exiting positions quickly throughout a day, hence the name “day trader.” A day trader favors market volatility, which brings about wild price swings. The day trader is able to use this volatility to make greater returns in stocks.

Drawback of Day Trading

Day trading is infamously unprofitable, especially for the majority of day traders. The overwhelming majority of retail investors who try to day trade end up losing money. In the long term, day trading is not a profitable strategy unless you have the tools and expertise to do it properly. Many investment banks, such as Goldman Sachs and Morgan Stanley, have trading desks, where proprietary traders (prop traders) use algorithms and high frequency orders to make small returns in fractions of fractions of a second. The same goes for hedge funds, which are funds that manage other people’s money and employ riskier strategies. However, these trading divisions at banks and hedge funds are becoming less profitable. If the big corporation is struggling to make day trading profitable, then surely the day trader will be having an even more difficult time.

Bottom Line

The investor seeks to find valuable companies to invest in the long run, while the trader seeks to take positions in stocks for short periods of time, hoping for price swings and market volatility.

In the long term, investing will make you generous returns. By doing research, and ensuring you are loosely following the markets and your portfolio, you can make excellent profits through good companies that have solid business strategies. Day trading requires work and the right skills to make it profitable.

About the author

Co-founder, Managing Editor and Contributor at StreetFins| + posts

I'm an incoming Stanford student passionate about financial literacy. I cover topics from personal finance to global economic news.