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Trading vs Investing Stocks


Trading vs. Investing on the surface these two strategies are very similar, the idea is to buy a financial instrument at a low price and sell it at a higher price. However when you look deeper into the strategies, the differences is great. So what is the difference between trading and investing? Most people will answer this question by saying that trading is short-term and investing is long-term. While this is not inaccurate, there are other important factors that distinguish the two, which are essential to understand in order to make money.

One of the key differences between trading and investing is the time frame of the transaction. Traders are quickly in and out of potions as one is aiming to capitalize on short term price movements. Thus when you enter a trade, like investing you do so always with risk management in mind, but the amount of portfolio risk varies. Most traders are looking for a least a 2:1 risk reward ratio, with a downsize portfolio stop of around 2%. An investment, on the other hand, is typically held for several months to several years or more. With an investment one would be less worried about the perfect entry condition and be able to allocate a 5% draw down in the portfolio before worrying about exiting the position.

The frequency of the transaction is another key difference. Trading usually consists of a large number of transactions, each with smaller gains. The idea is that many small gains add up to a large profit. An investor looks for large gains with fewer transactions. A trader is focused on changes in the price of the security. The underlying company may be the best-run company in the world or the worst run company. The price can go up or it can go down as long as the price of the stock moves the trader can make money. A trader looks at historical prices with the idea that past prices can be used to forecast future prices. It is very common to look at trends, moving averages, volume, or a number of other technical indicators to help predict the future movements of the security.

A trader spends most of his time looking at the charts of a security’s price and for the most part ignores the fundamentals of the underlying company or asset. An investor is less interested in historical prices and focuses her attention on the fundamentals of the company or asset. The purpose of an investment is to find a security that is undervalued by the market and will provide a return of capital gains and income that compensates the investor for the risk taken. Factors considered for an investment are the financial condition of the company, the quality of the management, the competitive advantage the company holds in the market, and the potential growth of the security’s price and dividends.

Discipline is the most important quality needed to make money trading or investing. A trader must use discipline to develop and back-test a unique strategy that has proven to profit in the past, strictly follow the strategy, and make sure that downside risk is minimized in each trade. An investor must be disciplined to carry out all due diligence in the research and valuation of the company, equally minimizing their downside risk.