Even if you’re relatively new to the financial marketplace, you may have heard the terms ‘investing’ and ‘trading’ used interchangeably.
At first glance, there appears to be good reason for this too, as both terms broadly require the commitment of capital in the pursuit of a viable profit.
However, these practices are fundamentally the same, trading should actually be considered as a distinct subset of investing, as there are central differences that must be considered before you select the vehicle that’s right for you.
I’ll explore these in more detail in the article below, while asking which of these practices offers you the best opportunity of achieving a profit. Let’s get into it!
Investing and Trading – A Brief Definition
Let’s start by exploring a brief definition of investing and trading, so that you begin to understand what each of these practices mean and their methodologies.
1.) Investing
Investing describes the practice of committing capital in one or a selection of asset classes, largely with a view to minimizing risk and optimizing returns.
Typically, investing is driven by a long-term market approach, as you look to accumulate wealth incrementally over time through assets such as dividend stocks and government (or commercial) bonds.
These assets have relatively long-term yields, while instruments such as bonds are also incredibly low risk and less likely to incur sizable or unexpected losses.
2.) Trading
While trading is also focused on the realization of profit through the financial markets, this typically relies on short-term strategies and a completely different grouping of assets.
Often, these assets are speculative in nature, enabling you to trade without assuming ownership of the underlying instruments and affording you far greater flexibility in the marketplace.
Of course, this also makes trading higher risk than investing, although profits can often be scaled markedly over time and in a way that best suits risk-hungry operators.
Investing and Trading – The Key Differences and Considerations
In addition to the requirement to risk capital in the pursuit of profit, both investing and trading also enable you to leverage market analysis and insight to arrive at truly informed decisions.
However, even the brief definitions of investing and trading highlight some core practical differences, each of which will have a bearing on how you operate and the level of risk you’ll be asked to compare. Here’s a breakdown of the most important differences and why they’re so crucial.
The Type Of Analysis Used
When engaging with long-term investment markets, you’ll generally concern yourself with so-called “fundamental analysis”.
This type of analysis looks in detail at influential macroeconomic factors such as interest and inflation rates, alongside the individual performance of and financial results produced by specific businesses (when appraising stock options).
Outside of stocks, fundamental analysis will review the performance of the wider market and its prevailing sentiment among investors, with this unlocking potentially insightful trends and observations.
Conversely, technical analysis is commonly deployed by traders. This practice leverages historical price data to predict future price movements, using key technical indicators and predetermined criteria (depending on your chosen asset class) to arrive at truly informed decisions.
While traders may also embrace aspects of fundamental analysis (I’ll touch more on this later in the piece), this is a key distinction when appraising investing vs trading and which method is best for you.
Trading is Inherently Riskier Than Investing
Despite the complexity and relative nuance of the global financial markets, it’s generally accepted that shorter timeframes increase risk and the scale of your potential loss.
This means that trading is noticeably riskier and more volatile than investing, as people who engage in this practice will often work in much shorter timeframes (sometimes even minutes when ‘scalping’), requiring them to enter and exit the market on a more frequent basis.
Ultimately, every market entry is fraught with risk, so the more times that you enter a particular market and commit your hard-earned capital, the more likely you are to incur at least some level of loss over time.
On a fundamental level, traders (especially those in the speculative forex space) often look to leverage price movements to their advantage, even those that are negative in nature.
This naturally increases risk, particularly when opening up highly leveraged positions that could cause you to lose more than the value of your initial deposit.
Passive vs Proactive Income
Putting your money in real estate is perhaps the quintessential investment option, as it typically delivers a long-term yield through a future resale or monthly rental yields.
In this respect, it’s best described as a passive investment asset, and one that can deliver relatively reliable and consistent gains over time.
This is typical of most long-term investment methods, including dividend stocks and position trading in the forex market.
Typically, this type of passive option requires less intense market analysis and is easy to automate, especially as investors are encouraged to ride out short-term price shifts.
Conversely, trading is associated with a more proactive outlook and much higher volumes, while those of you in pursuit of short-term gains will have to constantly open and close positions during each 24-hour period.
The key is to match your preferred market and methodology on your knowledge base, appetite for risk and wider strategy, as this will optimise your chances of achieving a return on your capital.
The Last Word
There’s no doubt that there are fundamental similarities between trading and investing, while these two terms are often used interchangeably as part of financial market jargon.
As we can see, however, there are also clearly defined differences between trading and investment, especially in terms of their respective timeframes, risk profiles and the types of analysis used to help inform decisions.
Understanding these differences is key, as this process can help you to choose precisely which vehicle is best for you, while even enabling you to create an effective strategy that optimizes your chances of banking a return.
