In the last two posts we asked “What is Investing?” and “What is Trading?”. This post will aim to answer the question “What is the difference between investing and trading”? This is one of the first questions I asked when I started looking into personal finance and investing and it has a relatively straightforward answer. However, there are also similarities between the two that I believe are worth exploring.
To begin, let’s look at investing and trading together. In the simplest form, they both put capital at risk with the aim of making money. I will not be discouraging you from either or promoting one or the other. Both are effective ways to make money in the financial markets, they just approach it in different ways. To show this as clearly as possible, I’ll break down the differences under a number of headings. It’s worth mentioning at this point that many of these headings will have posts of their own in the future.
Direction of Trade
Investors typically only invest in one direction. They buy (or go “long”) with the expectation that the price will rise*.
Traders can buy ( or go “long”) with the expectation that the price will rise. They can also sell (or go “short) with the expectation that the price will fall.
An important thing to note is that when trading, is that when you go short you are selling an instrument you don’t own. You must buy it in order to close the trade and realise any profits.
*Investors can actually go short if they invest in a fund that takes both long and short positions, but it is not a typical occurrence.
Investors take a long term approach to the markets. They buy stocks and hold them for an extended period of time, from years to decades. Investors are not overly concerned with day to day price fluctuations, they are looking for their asset to appreciate in value over a period of years.
Traders take a short term approach to the markets. As we discussed in the “What is Trading?” post, traders can hold a position from as little as a few seconds to as much as a few years. Depending on the style of trading, traders may place multiple trades per day.
Investors typically rely on fundamental data when choosing a stock. They want to know how the company is performing and how it will likely perform in the future. This isn’t to say all investors base their choices on fundamental data, an index investor will invest in the entire stock market, removing the need to research individual companies. As a general rule, fundamental data is important to investors.
Traders typically rely on technical data when choosing a trade. Technical data is based on charts and various indicators. Traders can pick what indicators they would like to use, or they may trade on the price action alone. Some traders may use fundamental data to outline their overall market bias. This would be most common with a position style trader.
Both investors and traders try to minimise risk and maximise reward, but as with most things, they approach it in differing ways.
Investors aim to minimise risk by spreading their investments over a large number of assets. This is known as diversification. A portfolio consisting of only stocks will be inherently riskier than one that contains stocks and bonds, which in turn will be riskier than a portfolio that contains stocks, bonds, cash and property.
Traders aim to minimise their risk by only risking a certain percentage of their account on any one trade. This can vary by trading style but let’s take 1% as an easy example. With an account of €100, our imaginary trader is willing to risk losing €1 on any given trade. His target is likely to be a multiple of that but this again will depend on the trading style.
The payoff for the risks taken above are the financial rewards that investors and traders get. As with most points in this post, there are no hard and fast rules as to how much of a return a trader or investor should achieve.
Investors will usually look for a yearly return of 7%+. This is only an average, some years will be above and some years will be below. The magic of long term investing lies in compounding interest, a process whereby returns are re-invested and receive returns of their own in years to come.
Traders returns can be more difficult to quantify as they tend to be less reliant on the overall market and more influenced by the trader themselves. A return of 10% per month would typically be seen as a good month for a trader.
Dealing With Losses
Investors are in it for the long run. They will usually ride out losses and have no problem holding onto stocks that have lost them money (providing the fundamental data has not changed).
Traders will try to cut their losses. If they are in a losing position, they may close it immediately even before it hits their stop loss (a pre-determined exit point). There is an old saying in trading; “Cut your losses and let your profits run”, but as with almost everything to do with trading, this is only applicable to certain trading styles.
While both investors and traders will close a losing position if the underlying rationale has changed, traders are usually much quicker to do so.
Once again, the amount of time spent in front of the screen can vary greatly depending on your style of investing or trading. These are just rough outlines.
Investors don’t spend much time in front of the screen. As they are primarily focused on long term outcomes, day to day fluctuations don’t matter that much. Most of the time an investor spends in front of the screen will be focused on fundamental research in terms of individual stocks, or perhaps rebalancing their portfolio (a monthly occurrence usually).
Traders spend a lot more time in front of the screen and as a rule, the shorter the timeframe of your trades the longer you will be looking at the screen. In the case of a scalper, they will be constantly monitoring the charts for possible entry and exit points. There is a caveat with this, traders may focus on certain periods of the day to trade (e.g Wall St. opening hour or two). Even though they may trade small timeframes they are only spending two hours or so trading per day. As such the time spent can vary but it is generally more than that of an investor.
As I mentioned at the outset and in previous posts, there are similarities between investing and trading and some skills common to both. I don’t believe they are as important as the differences, particularly at the beginning of your financial journey so I’ll cover them briefly.
- Both risk capital to make capital.
- Both are heavily influenced by emotions which is why Stoicism can benefit both.
- Both require a structured approach via a trading or investing plan.
To wrap it up, investing and trading are both concerned with the same thing; making money. Which one you try is up to you and there is nothing wrong with trying both, just make sure you are willing to put in the time.
The Stoic Trader