There exists so many technical words in the financial world that we often get confused as to what is what. One of the most common examples of this is using investing and trading interchangeably thinking they have the same meaning.
But the truth is that they are not the same and both are distinctly different. We should look at investing and trading as long term vs short term.
If you are looking to invest in the market then you are looking at long term gains over a period of time which is what investing is. But if you are looking at making quick money in a short period of time then you leaning towards trading.
For example, if you are buying shares in Naspers in anticipation that the company would do well in future & also the price of Naspers’s stock will go up in a few years then you are investing in Nasper’s stock long term.
In contrast, if you are looking to place a buy order on Nasper’s stock with an aim to sell it at the end of the day for a quick profit, then you are day trading.
These are the two different approaches to take while dealing with the financial markets. The approach is solely dependent on what you expect from the market.
What is Investing?
The idea behind investing is to build a portfolio of financial assets over a period of time that would bring consistent return on investment. When you are looking to invest, you set long term goals for yourself and make investments accordingly.
The investments can range from buying stocks on JSE to buying government or corporate bonds or investing in real estate or starting a business, what you decide to invest in will solely depend on the approach you take after taking into consideration various factors.
Unlike Term deposit with banks, there’s no surety when you are investing in the financial markets. You don’t have the guarantee of seeing fixed return on investments. So, there is always a concern about the risk involved.
One of the main aspects to consider while investing is what is the level of risk you are willing to undertake. The risk associated is always a major factor involved in decision making.
For example, if you invest R100,000 in a Fixed Deposit Account which yields a return of 7% per annum, you will generate R7000 every year regardless of what happens. This is the security benefit with investing in a Fixed Deposit Account than other financial securities. Though the returns are small, they are consistent.
On the other hand, when you invest in stocks which can react to market volatility, there is a possibility that you can double your investment in a few hours or days during market volatility. But this also means that you can lose all your money in a few hours or days if the market is acting against you.
But an astute investor would not be worried about short term volatility in securities, and only look to invest long term in the markets after doing proper due diligence of company’s cash flows & balance sheet.
To find the optimum level of risks while also ensuring that you get consistent returns is the goal of every investor. This is why many investors look to have a diverse portfolio to ensure that they have revenue sources from different financial assets to help balance the portfolio.
If you are looking at long term investing, there’s also the idea of the short-term losses you can suffer. For example, if there’s a trade embargo between China and US, major stocks could take a hit since there will be shortage in sales as supply chains could be hit.
But an investor would understand these risks, and only buy stocks that have good long-term business & cash flows.
You can ride out short-term losses by holding onto good securities for a long period of time before selling it in the market for a much higher price a few years later, or earning value from the dividends.
Investing involves lesser risks compared to trading but there can be instances where you will have to incur short-term losses to make money later.
What is Trading?
The goal behind trading is to make quick short-term gains. As a trader your goal would be to speculate on or buy stocks, currencies or other financial assets which have high liquidity and flip them for a higher price when the market is functioning according to your predictions.
A trader would normally place a buy or sell order on a financial instrument of their choice at the start of the trading session through retail or CFD trading apps or Retail Brokerages and close their order at the end of the day to take profit.
Most traders rely on trading charts & technical analysis for prediction of future near-term price movement. They might also rely on news that could add short term market volatility.
For example: In Forex Trading, if there’s a news that due to some political instability, the Euro is going to drop massively. You would buy another currency against the Euro or you would sell the euro since the market volatility could affect Euro as per your predictions. But this is not a certainty.
One of the main reasons why people prefer trading to investing is the possibility of faster returns involved. You have the chance to make millions if you get your predictions right. But traders usually take big risks only if they have sufficient funds to cover their losses.
Compared to investing, trading is highly risky and you need to monitor the market closely. It’s due to this that traders take up trading in the financial market as full-time jobs due to the amount of work involved in buying/selling commodities, stocks, forex or currencies etc on regular basis.
In trading, traders have various instruments that can be traded, and various tools like stop-loss. A trader can set the stop-loss & take-profit to determine how much profit he wants and how much loss he can handle. These tools allow traders to make calculative trades and help minimise their losses or get consistent profits.
The most common trading instruments that a trader can trade is:
- Currency pairs or Forex Trading
- Stocks
- Indices like JSE40 or Nasdaq 100
- Commodities like Gold, Silver or Crude Oil
And there are currently four types of categories that traders can be classified into:
Position Trader: You hold onto your position for months/years.
Swing Trader: You hold onto your open position for days/weeks.
Day Trader: You hold onto your position for a day and not have any overnight positions. Normally the trades are intraday.
Scalp Trader: You hold onto the instrument for seconds/minutes and not have any overnight positions.
Which one is best suited for you?
There is no right answer to this.
Both investing and trading have their own pros and cons but it all boils down to you and what you are looking at. More than the market, this choice lies in what type of personality you have.
More than anything, it’s your goals and expectations, risk appetite that will help you choose which path to take.
Here are a few pointers that you can use to see which category you fall in:
- The expected returns and the time period: If you have ample amount of funds and you are looking to get consistent returns on your money over long-term & not worried about the short-term market movements, then the best way to go about this is to invest to have a diverse portfolio with different financial assets. If you are looking to make quick money then you should consider trading in the market to get short terms gains. Depending on the returns you want and the time you can wait for it, you can decide between investing and trading.
- The risk to reward ratio: You must have a pretty good idea now about the risks involved in the financial markets. So, if you have sufficient funds to back high risk moves then you could get into trading as the potential rewards are higher as well as the risks. But if you are looking to keep your funds secure in long run without suffering due to market volatility, then you need to consider investing as the risk ratio is fairly lesser compared to trading and the possible rewards are also low but consistent.
- Time: It is not at all easy to trade in the financial markets as you have to constantly stay updated on the market. You will need to spend a lot of time and effort in monitoring the market as well as researching and conducting due diligence. If you are doing some other business then you cannot trade regularly as trading requires a lot of time and patience. Also, the possibility of losses in much higher. On the other hand, you can invest in various financial securities without having to worry about monitoring it every day, once you have done the proper due diligence & invested for the long term.
Before you decide whether you want to invest or trade, you need to think about the returns, risk and time involved in both.
Overall, trading is riskier because it involves speculation. Trading could mean potentially higher short-term returns, but the possibility of losing it all back is also higher.
Investor would seek lower risk portfolio of 5-10% ROI annually, but a trader might make 10% on a single trade. And the obvious downside risk would be higher in this.
Regardless, both investors & traders should spend time to learn about the different asset classes, understand the risks, use money management. Risking 2x to make 1x is never a right investment.
