Investment and trading are often confused with each other. Where both are similar in a way that they aim at using money to make more money by buying and selling, the main similarity ends here. They are both very different approaches to making money. In this article, I am going to look at the similarities and differences between the two approaches and how to choose what is better for you.
What is trading
Trading generally means buying things on a regular basis with the intention to sell them at a profit. It can be anything but here we will keep our discussion limited to anything traded on the exchanges, including currencies, commodities, stocks, options and ETFs. The objective of trading is to buy and sell more frequently for smaller profits over shorter periods of time. The traders usually take both long and short positions (positive and negative balances of the assets in the trading account) to utilize even the smaller moves in prices irrespective of the direction, in order to maximize the profits. It is a more aggressive approach aiming at compounding smaller, more frequent profits to give a higher return on capital. This approach is usually riskier and needs more time and effort to implement properly.
Traders are more focused on technical analysis as compared to the fundamental analysis. This inherently means making decisions based on the historical price data and the chart patterns with less focus on what the company does and the longer-term prospects of the company or the industry it operates in.
What is investment
Investment is the more laid-back approach to money making as compared to trading. Investment also aims at buying and selling an asset with the intention to make profits; however, it is focused on buying and selling less frequently and holding for longer time periods in order to obtain larger profits.
Investors focus more on the fundamental analysis of the company which means analyzing the financials of the company, the industry it operates in, the macroeconomic factors and the details of the company operations giving a clear picture of the long-term prospects of the company.
Investment usually involves much less risk as compared to the trading but the potential profits are also less than trading. As the frequency of trades is less, investment takes less time and effort, and in turn, is less stressful than day trading.
The biggest difference between trading and investment is the approach. Trading focuses more on increasing earnings by compounding the smaller profits more frequently in order to provide the highest return on investment. While the investment is more focused on wealth creation and management. One is a more active approach that needs constant attention and frequent actions while the other is a more passive approach to increase your wealth over longer periods of time. While the investors may be content with 10-15% annual return, traders seek the same return every month. As the return increases, the risk also increases which makes trading more stressful than investment. Below are the key differences in the two approaches.
- Time period – investment, as mentioned above, involves a more hands-off approach where the investments are made and held for years. For investors, short term price fluctuations are not very significant. On the other hand, trading is mainly focused on the smaller fluctuations in price irrespective of the longer-term movement. Trading periods can be as short as seconds for scalp traders with no overnight holding. Other traders may hold their positions for days or even weeks.
- Return on investment (ROI) – investment is focused on making decent profits over a longer period of time and reinvestment of profits to gain better returns. The traders on the other hand focus on maximizing the profits through compounding smaller gains. They take both long and short positions to benefit even from the smallest of the price fluctuations, giving a higher overall profit rate as compared to investment.
- Risk – as the fundamental approach of the two methods is different, the risks they carry are also hugely different. Trading, especially long short trading, is usually riskier as it focuses on the smaller fluctuations in the smaller time frames which are more difficult to predict. Investment, on the other hand, also carries the risk of losing money but as it focuses on the long-term company prospects instead of price fluctuations, is usually less risky as compared to trading.
- The difference in approach – investment and trading follow very different approaches in making profits. The main focus of investment is on fundamental analysis of the company prospects and the attractiveness of the environment it operates in. It gives less weightage to the short-term price fluctuations in the market in order to make safer and more predictable investments. Trading, on the other hand, is a more aggressive approach to money-making which is more profitable as well as riskier and requires more hands-on attention.
Which one is better?
There is no single answer to which one is the better approach between investment and trading for making money as it all boils down to your personal circumstances and priorities. If you want to make huge profits in the short term, trading is the option for you. However, it needs more knowledge and practice and carries significantly more risk than investment. Without proper training and preparation, most of the traders lose money. Trading is also more stressful and you will need to follow strict discipline in order to train your mind for making the right decisions. All that said, the higher rates of return can be very rewarding once you get the gist of it.
On the other hand, if you are looking to slowly build your wealth over a longer time period and focus on your career at the time, investment is a more suitable approach for you. It needs less attention and less of your time and is less stressful as a whole. However, it does not mean that you do not need the study and preparation for investment.