Trading in the stock market has always been a very attractive activity since the long bullish market of the 2010s. However, the Stock market has witnessed a tremendous amount of new traders amid the 2020 Coronavirus pandemic.
Many successful traders who choose to share their returns in the public domain have become social media stars. Perhaps even you have a friend or family member who jumped into the trading scene during the period. And wondering if you should risk your hard-earned money in the stock market.
If so, it is essential for you to understand the difference between Trading and investing. Understanding the differences between these two activities can help you make better decisions about your financial goals.
Trading and investing are two very different ways of mobilizing your funds in the Stock market. While Trading, A trader aims to capitalize on short-term market fluctuations to make a profit in a short period of time. As such, traders often look to buy and sell stocks quickly and may use tools such as margin and leverage to increase their profits. On the other hand, investing is a longer-term approach. Investors typically buy stocks and hold them for an extended period as they look to benefit from gradual growth. Unlike traders, investors look to build a diversified portfolio of stocks and stick with them through the ups and downs of price movement.
Many investors – particularly individuals – may want to avoid Trading altogether due to its high stakes and inherent risks. Alternatively, some people may want to allocate part of their available funds to Trading and the rest to long-term investing. In this article, we’ll look at each strategy’s basics and pros and cons.
The Basics Investing
Investing in the stock market involves purchasing assets such as stocks, bonds, mutual funds etc. and holding them for a long period of time. Investors typically have a long time horizon and predominantly aim to generate wealth over steady appreciation in the asset’s price and the power of compounding.
It is important to understand that the longer the horizon of investment, the Higher the chances of it giving good returns. Investment is a long-term activity, so it is usually recommended to keep your money in a savings account if you need it within 3 years. If not, investing the money would give you better results.
Investors should diversify their portfolios to lower their risk, mostly by minimizing the consequences of volatility (rapid, sharp, or sudden changes in values or price). Through mutual funds and exchange-traded funds (ETFs), which are single investment units containing a variety of or a large number of assets, investors can instantly diversify their holdings. When choosing the asset mix for your portfolio, taking your risk appetite and holding Capacity into account is crucial.
Suppose investors must choose individual stocks or bonds. They will typically employ fundamental analysis. Fundamental analysis is a method to judge an investment based on its intrinsic value. By looking at various criteria such as its profitability, history, or creditworthiness
The Basics of Trading
Trading in the stock market involves buying and selling stocks or financial Instruments, such as futures and options, in a short period of time. The aim is to profit from short-term price movements. Traders typically use Technical Analysis to predict price movements and capitalize on them. At the same time, Investments last for long periods, Typically years. A trade can be taken for weeks, days, or even minutes.
Day trading and swing trading are two of the most popular types of Trading. In contrast, Day trading means taking up and closing positions within a single trading day. Swing trading involves holding the positions for days, weeks or months.
Traders rely heavily on Technical Analysis, As Fundamental analysis is close to irrelevant when it comes to predicting price movements in a shorter time frame. Technical Analysis is the study of Historical price data, such as price patterns and behaviour, to predict future price moves.
Technical Analysis is a very reliable way of predicting future price moves. It is a very talked-about subject among trading enthusiasts right now. Many skilled technical Analysts have become Social media stars due to the ongoing buzz about technical analysis. However, It should be important to understand no matter how skilled you are in technical analysis. No one can predict future price moves with 100% accuracy. This is why it is recommended to use proper risk management techniques while Trading.
Trading is a complex activity and can be very risky if not done correctly, which is why it is recommended to trade with small quantities if you are just starting out and protect your positions with proper stop loss orders.
Comparing Trading and Investing
While both Trading and investment involve buying and selling financial instruments, both are very different methods, With different goals, which makes a generalized comparison difficult.
However, in an overall Comparision. Trading is risker and more complex for various reasons, such as
1. It requires more time and close monitoring
2. Much risker owing to the usage of leverages.
3. Requires quick decision-making and control of emotions.
Trading, it should be emphasized, can also result in greater profits. Investors can aim for an annual return on their portfolio of 8% to 10%. However, a trader might seek to make that much or more each month. The uncompounded annual return for even traders who made “only” 5% per month would be 60%.
Due to these factors, it is challenging to declare any approach as the “Best” Investing will be the best course of action if you have a lower risk appetite and wish to avoid volatility. Trading, though, can be alluring if you’re a risk-taker who wants the possibility to make large profits quickly.
It’s crucial to realize that investing and Trading aren’t Necssialry incompatible activities. For instance, you might allocate 90% of your funds to a diversified portfolio that you’ll hold onto for the long term and save 10%, or your “play money,” for speculative Trading in a short time frame.
Why do investment returns outperform trading profits?
In general, Investment returns typically ( not essentially) out performs the trading returns for the following five reasons.
Investing is where the power of compounding shines. Compounding implies that the longer you own stocks, the more money they make and, thus, the more money you make. Trading involves frequent churning of the funds and the portfolio. Thus the power of compounding has very little chance of benefiting you.
The lengthier tipping points of stocks are synchronized with investing. This has major significance. Take Infosys as an example. Infosys began operations in the early 1980s, but it took the company 16 to 18 years to establish a solid customer franchise, achieve economies of scale, and develop a successful business strategy. Trading simply can’t capture a cycle of performance this long.
Trading involves incurring a cost per transaction. Although this is a relatively unimportant matter, transaction expenses can significantly impact your actual returns. The cost of Trading is high when you consider brokerage, statutory expenses, and hidden fees like illiquidity and spread hazards. Trading is much less cost-effective than investing.
The influence of taxes on Trading is one. You report the proceeds as business income or as recent capital gains when you trade. In any case, you pay the maximum tax amount, typically around 34.5%, after the surcharge. Even with the recently implemented tax on long-term capital gains, long-term capital gains are still comparatively more cost-effective.
Which is Better for You?
Now to understand, Which of these methods is better for you. It would be best if you defined several criteria for yourself. Such as your risk appetite, your ability to control your emotions, the amount of time you can hold positions, and the amount of time you can spend analyzing and watching the market.
It is not necessary to choose between one; for example, you can choose to invest a part of your capital and trade with the rest. The best way to choose is to do your research and try your hand with small quantities.
Trading and investing in the stock market are two different activities that involve different levels of risk, time frames, and tax considerations. Before engaging in either activity, it’s important to understand the similarities and differences between Trading and investing and your own risk profile and investment goals. By understanding the basics of Trading and investing in the stock market and the factors to consider when deciding which activity is best for you, you can make wiser decisions about your financial goals. Yet it is important to note that both Trading and Investing have a potential loss. This is why it is important to diversify your money in various segments and use proper money management techniques.
If you are a risk taker, Trading with a portion of your funds can be fun and profitable. If minimizing risk and exposure to volatility are your primary objectives, you should continue investing long-term. A slow-and-steady investment strategy is ideal if you’re saving for a financial goal that you want to achieve by a certain date.
Harshit Senani is the Co-Founder of Thrive In Trade and many more Educational institutions. Harshit is a trading and investing enthusiast. He writes intending to educate people on subjects like Finance, Technical Analysis and Money Management.