Trading vs. Investing: Understanding the Key Differences
‘Trading’ and ‘investing’ are two words that are used commonly in any conversation related to the stock market. But, in reality, there is a fundamental difference between trading and investing in the stock market. So, before opening a demat account, we should know the difference between these two.
The most important difference is that trading is short-term in nature. Typically, a trader wants to encash the ups and downs of the stock market over a short period. In contrast, investing is long-term in nature. An investor invests his money in a stock for a long period (typically more than a year).
But, this is not the only difference. Therefore, this blog will explain in detail the difference between trading and investing in the stock market.
Difference Between Trading And Investing In The Stock Market
Duration
A trader typically invests for less than a year. As an activity, trading account requires more frequent transactions than investing. Whether dealing with shares, commodities, or currencies, a trader is more keen to know than an investor how much a share or a commodity is likely to move up tomorrow or the day after.
On the other hand, an investor invests for a longer term than a trader. Typically, an investor invests for a year or more. Short-term changes do not affect an investor’s decision.
For example, suppose the president of a big economy dies suddenly. In this case, the stock market of that country and other countries may remain volatile for a few days.
An investor will not care about such an event unless the death of that president has a fundamental impact on his investment.
However, a trader will like to cash in on the ups and downs of the stock market resulting from such an event, even if such ups and downs are not due to any fundamental reason.
Modes
An investor can invest in a stock and actively manage his investment. This is called ‘active investment’ because the investor is himself managing the investment.
On the other hand, he can invest in a mutual fund or exchange-traded-fund (ETF) and let the manager of such a fund manage his investment. This is an example of ‘passive investment’ because the investor is letting someone else who is an expert manage his investments, without doing so himself.
There are different modes for a trader to trade. For example, he can be a day trader, wherein he can buy and sell a share in a single day (hoping to make some money) without taking any overnight positions. Or, he can be a swing trader, which will require him to hold a position for days and at times even for weeks.
A swing trader looks at charts and tries to understand patterns of stock market movements. If he thinks a stock will go up, he buys it hoping that he will be able to sell it later at a higher price. If he thinks a stock will go down, he can sell the stock now and buy it later at a lower price. Similarly, there are other types of traders, like position traders, scalp traders, etc.
Risks involved
Typically, trading is considered riskier than investing. This is because trading depends upon ups and downs in the stock market over an extremely short period, like a day. Unless you are an astute trader, chances are that you may not be able to correctly predict the direction of the stock market. In that case, you may end up incurring losses.
On the other hand, if you invest, you will be staying in that investment for a longer period; therefore, the probability of making a loss is lesser than in trading.
Besides, if you invest in a mutual fund or an ETF, a professional fund manager will manage your investments. Since such professionals have deep knowledge of the stock market, the chances of your investment resulting in a loss are much lesser compared to trading.
Conclusion
Anyone with a trading account can invest and trade. What is important is to understand the difference between trading and investing in the stock market and have a good grip on the risks and rewards of both these activities.
