There are many similarites in trading vs investing, but there are some key differences between them.
When I began FX trading over 10 years ago, I wouldn’t have been able to explain the core differences in trading vs investing.
It was many years after starting out as a trader that I got more interested in investing. My knowledge of both increased along the way and it’s important to know the differences between them.
So keep reading to find out more about 8 key differences between trading vs investing.
What is Trading?
First, let’s begin by taking a look at exactly what trading is. Trading, also known as day trading or active trading, is a method of buying and selling assets over shorter periods. By short periods, I mean the space of a couple of minutes for day trading and up to around 3 months for a long/short portfolio manager (more on this below).
Traders aim to make money through volatility in markets, which is essentially a measure of movements in the price of an asset. By its nature, trading is more speculative as a trader seeks to profit from spikes in volatility, whether prices go up or down.
A trader will often use derivative contracts to take a position on an asset rather than buying the underlying asset itself. For example, in the UK, many retail trading brokers will offer the ability to trade using Contracts for Difference (CFDs). Instead of buying the underlying asset, a trader will take a speculative position on the price of the asset, and any difference between the entry price and the exit price will be a profit or loss on that position.
What is Investing?
On the other hand, investing usually involves directly buying a share, or taking a position, on an underlying asset. This could be buying shares in a company (equities investing), buying a stake in a property (property investing) or buying physical gold (commodities investing).
By directly holding an asset, or a share of it, this means an investor may make income from it as well as profiting through any price increase in the asset itself.
Investors also tend to have a longer term view and will retain their position in an asset over a longer time period than a trader. Typically this could be anywhere from 3 to 10+ years.
The goals of an investor are often more diverse than a trader. An investor may seek to take an income from an asset they have purchased, such as dividends on shareholdings. A trader, however, will usually not be concerned about any dividend payouts.
Trading vs Investing: 8 Key Differences
Time Horizon
Investors usually seek to maintain a position in an asset over several years, depending on their exact goals. They will be less concerned with any short term market movements as they aim to grow the value of their investments over a sustained period.
If an investor is seeking an income, they will often need to be invested for a minimum period of time to be eligible to receive it. For example, some companies will pay a quarterly dividend. For an investor to be able to share in each of the payouts they will need to maintain their shareholding throughout the year.
If markets decline in value, for example during a recession, investors will often seek to ride out the price drops. This is particularly true for investors with a very long term holding period.
Some investors may sell off some of their positions, and re-enter the market when they view the recession to have reached the bottom.
Traders on the other hand will actively seek to profit from falling prices. They will generally have a much shorter time horizon when holding their positions.
During a recession, traders may seek to enter and exit the market over a short period to make profits on the back of large price swings in assets such as shares. This includes selling short (more on this below), which allows traders to profit from falling prices.
Some traders may only stay in a trade for a matter of minutes or even seconds. This method of very short term trading is called scalping, and this was the first trading technique I learned when I began trading at the age of 19.
Day traders will stay in a trade a little longer than scalpers, but will seek to close out their positions by the market close of that day. They often use technical analysis (more on this below) involving charts and trendlines to evaluate trading opportunities.
Swing, or momentum, traders aim to take advantage of markets moving in a particular direction over a period of days or weeks. This is often seen once a recession has hit its trough and markets begin to recover.
The type of trader who tends to be invested the longest is known as a Long/Short Portfolio Manager (L/S PM). This is my current preferred method of trading. I may be in a trade for a matter of weeks or up to 2-3 months, depending on the position.
Volatility
It’s often said that volatility is a trader’s best friend. And believe me, it is. When I started out as a Foreign Exchange (FX) trader over 10 years ago I remember days would go by with relatively little movement. At least in the currency pairs I was interested in.
Volatility, and in particular implied volatility which is forward-looking, is a measure of your opportunities in the market. In simple terms, it represents a measure of the movements in prices of a given asset or market.
If prices move, that means there’s an opportunity to take a position on the asset and make a profit on that price movement. If prices aren’t moving, it’s very difficult to make money!
So, being able to predict volatility is a key part of being a trader. But it’s the opposite if you’re an investor. It’s also often said that volatility is an investor’s worst enemy.
Investors typically want to see a sustained increase in the price of an asset. A high rate of volatility can mean prices fluctuate which can cause problems for an investor looking to exit or enter the market. Investors prefer to see steady growth in their portfolio of investments over time.
Short Positions
Investors seek to grow the value of their investments over time and to do so they will buy and hold an asset over time. Eventually they will aim to sell the asset for a price higher than they paid for it. Investors who buy and hold assets in this way are known as long-only.
Another key difference in trading vs investing is that a trader can also sell (or short) an asset even if they don’t own it in the first place. In this way, traders can take advantage of falling prices of assets, such as shares, by shorting them.
Shorting involves a somewhat complicated process of borrowing a share owned by an existing shareholder, selling it to someone else, and buying it back at a later date when the trader expects the price to have fallen. They then return the original share to the owner.
This is a highly risky transaction, and traders can often lose more money than they originally committed if the trade moves against them.
For retail investors, shorting shares can be done more easily than the process described above by using CFDs through a retail broker.
Opportunity Set
Investing for most people is primarily concerned with buying shares. More broadly, investors may also invest in other assets such as property (directly or through REITs) or bonds, but they tend not to invest outside of these options.
By contrast, traders can and do trade in a large range of financial assets and instruments. These could be through CFDs, forward and futures contracts or options. These are types of derivatives contracts, where you do not own the underlying asset or at least do not intend to take delivery of the underlying asset.
For this reason, traders are able to take part in a wide range of markets and often specialise in a particular market or type of financial asset. For example, my trading journey started as an FX trader before I later began trading in shares.
This variety of options, or opportunity set, allows traders to be able to take advantage of a wide range of factors affecting markets.
Use of Leverage
Leverage is essentially borrowing more money than you have in your account to increase the size of the position you’re able to take in the market. Doing this means you will be operating on margin, and you will need sufficient funds in your account to be able to maintain that margin.
Using leverage in this way is highly risky, and for retail traders can sometimes lead to losses greater than the amount you originally put into your trading account. On the other hand, you can make greater profits than you would otherwise have made, as your position is multiplied up by using leverage.
If you’ve ever used a retail trading app, such as Trading212, you may have noticed a financing charge. This will occur if you trade in CFDs and stay in a trade for more than one day.
This is because the retail broker is effectively lending you money to be able to leverage your position in the market. To do so, they charge you a financing fee each day that the trade is live. Think of it like paying interest on a short term loan.
Investors will rarely, if ever, use leverage or any form of borrowing to fund their investments. They will only invest using the cash they have. Often they will reinvest gains from selling investments at a profit and any dividend income over time to compound their returns.
Risk Management
Whether trading or investing, the first goal of anyone who puts their money into financial assets is to preserve their capital. In simple terms, they don’t want to lose any of the money they’ve invested.
This might sound like an obvious objective but in retail investing and trading, many – often most – people will lose money rather than make money. Risk management is a hugely important factor.
For investors, who we know seek longer term returns, it is especially important to preserve capital. As pointed out above, investors do not use leverage which means investing is less risky for this reason alone.
Other factors make investing less risky than trading, including that investors tend to make fewer transactions than traders (they have lower liquidity risk) and partly because a longer time horizon smooths out short term price volatility.
Many investors will seek to minimise risk by diversifying their investment portfolio across a range of sectors and assets to avoid a reliance on any particular sector/market on its own.
Trading tends to be a riskier proposition. Using leverage can multiply profits as well as losses for traders, and losses can even exceed the account balance if not managed appropriately.
Traders will manage the risk on each trade and often will hedge their positions. Hedging is where a trader will reduce the potential losses of a losing trade by placing a simultaneous trade on another instrument with a different level of exposure to the primary trade.
Another risk factor for trading is volatility. Despite it being a trader’s best friend, unexpected market volatility could cause a trade to quickly become loss making. For an investor, they may simply hold their position and seek to ride out the volatility.
A trader however may have their position closed out by their broker for a loss if they’ve used leverage and become unable to maintain their position in the market. This is known as a margin call.
Strategy & Goals
While both investors and traders seek to preserve capital as their primary goal, there are differences in their strategies and their return targets.
Investors may seek to grow the value of their portfolio over time. Or they may seek to receive an income from their investment portfolio. Each approach requires a different strategy.
An income investor will be less concerned about the potential of a company’s share price to increase in future, and more interested in their dividend yield. They are also likely to be interested in investing in bonds, which pay fixed interest payments over time.
On the other hand, an investor seeking to make longer term gains on the value of their investments will want to ensure they are invested in shares (or other assets) with the potential to increase in value.
They will also tend to be less interested in dividend payouts as generating an income is not part of their strategy. Additionally, they’re less likely to be interested in buying bonds which tend to have more stable prices (less volatility) than shares.
Although traders may have different strategies depending on a number of factors, their primary goal is simply to make a profit on each trade.
Traders generally do not place much emphasis on dividends and fixed income payments from bonds.
Approach and Analysis
There are two main types of analysis when it comes to trading approaches. The first is called technical analysis, which mostly relies on charts, trends and statistical analysis that relates to price action only.
A trader who relies on technical analysis will look at indicators such as moving averages, support and resistance lines and other types of on-chart analysis. Typically they will ignore wider economic and industry level analysis. When I first learnt to trade, I only used technical analysis.
The other main type of analysis when it comes to trading or investing is called fundamental analysis. A trader who ‘trades on fundamentals’ will look first at underlying analysis that’s specifically about the sector and security being traded.
They will still use statistical analysis when doing so, but they will generally ‘form a view’ of the market based on wider economic factors, such as the business cycle. That view will either be long or short, i.e. they will decide if markets will rise or fall.
Once they have formed a view of the market, they will then look at specific sectors, for example oil & gas or banking, and form a view of that sector. A trader could for example be long on developed equities and long on the banking sector.
A sophisticated trader will generate trade ideas and carry out fundamental analysis first, and then use technical indicators to time their entry into the market. They do not rely on technical indicators alone.
Whilst a trader may rely on one or both of the above methods, an investor’s approach will be almost entirely based on fundamentals. This is partly because they take a longer term view of the market and, over time, fundamental factors will determine longer term trends.
Trading vs Investing: which is best for me?
The above 8 differences in trading vs investing may have given you an idea of which you feel you’re best suited to. When starting out, it’s a good idea to learn as much as you can about trading and investing, and take the time to understand the risks involved in both.
Retail trading or investing can be done from home, and even from your fingertips through an app. For more ideas on making money from home, check out our guide to genuine work from home jobs.
