Investing vs. Trading: What’s the difference?

Whilst there are some similarities between the two, trading and investing are two different ball games.

Let’s look at Investing first

Investing is a long-term approach to making profit in the markets, you are typically looking at holding your asset – can be Stocks, ETF’s, Index Funds, Commodities, Bonds for several years to even decades.

We call the length of time you hold an asset “time horizon“

When you invest in an asset, you are betting on the long-term appreciation of its value. As an investor, your time horizon is long-term and you do not care about the short term price fluctuations. Investing requires a rigorous research process as you are in it for the long run. For stocks, a great emphasis is placed on fundamentals such as the financial health of the company, the economy, etc.

Investment Styles

Growth Investing – This approach seeks to find stocks that have a high growth potential in the future.

Value Investing – This approach seeks to find stocks that are currently trading below their intrinsic value (under-valued).

Now let’s look at Trading

Nike Inc. has experienced a 937% growth in share price since the bottom of the 2008-09 financial crisis.

The chart shows that the long-run trend is upwards, however, in the short-term the share price fluctuates a lot.

Now this is where trading comes into place. As a trader, volatility is your bread and butter because you can take advantage of share price fluctuations to make a profit. With trading, you can make a profit when asset prices are rising or falling.

Therefore, we can define Trading as the “Buying and Selling of financial assets to make a profit”.

An Investor would have bought Nike back in 2009 and continued to reinvest profits, whereas a Trader would trade in and out capitalising on the fluctuations in price.

The dips shown in the chart are called corrections or pullbacks, depending on how much the price falls.

Bulls vs. Bears

This has been an unprecedent year in global markets as the price of oil experienced a historic crash. This is was mainly due to lockdown restrictions around the world which dampened the global demand for Oil, amongst other factors.

Using basic supply and demand dynamics, one could anticipate that the low demand for Oil would lead to a fall in price.

In order to take advantage of this opportunity, you would take a “Short” position (Sell) on Oil. This is when you bet the price or value of an asset will fall. This is known as being BEARISH and investors/traders who are bearish on an asset are known as Bears.

If you are bearish on Oil, you would take a short position at $42 and if the price falls to $10, you would make a profit. However, if the price goes up to $50, you would make a loss.

Now when lockdown restrictions were eased around the world, the demand of Oil picked up again, so we would expect the price of Oil to rebound. In order to take advantage of this opportunity you would take a “Long” position (Buy) on Oil. This is when you bet that the asset price is going to appreciate. This is called being BULLISH and investors/traders who are bullish on an asset are known as Bulls.

If you take a long position or buy at $42 and the price goes to $50, you would make a profit. If the price falls to $10 you would make a loss.

Long and Short Positions: An example using Stocks

If you are optimistic about Nike’s future performance, you would take a long position at $112. If the stock price goes anywhere above your entry price, you make a profit, conversely, if the stock price falls anywhere below your entry price, you make a loss.

If you are pessimistic about the future performance of Nike, you would short or sell at $112, and if the price falls to say $90 the profit you make is $22, however, if the price goes to say $140 you would lose $28.

Profit/Loss = change in share price x number of shares, whether you have taken a long or short position.

side note – A loss or profit is only realised when you actually close your position. If you are in a long position, the stock price can fall below your entry price, before going up.

So, with trading you can make money when markets are going up or down, you just need to be on the right side of the trade. Although this seems ideal, it presents it’s own challenges.

What makes trading relatively more difficult than investing is the fact that timing these trades is not an easy task. In addition, as you are dealing with short-term time horizons, psychology and emotions play a much bigger role. You are more prone to making irrational decisions, whereas when you are investing, you would perform a deep dive into the companies financials and future prospects hence attempting to time the market is not as important.

Someone might be wondering how you can sell a stock if you don’t own it in the first place.

The way it works is:

Recall that Investors do not care about short term price fluctuations, so through your broker you can borrow their shares, sell them at $112, and then buy them back at $90, return the shares and the difference is your profit.

However, with brokerage platforms such as Trading 212 or E-toro who use CFD’s (Contract For Difference), all you need is to do is press SELL to take a short position and it takes milli-seconds to execute.

At first the concept of shorting takes a while to get to grips with, but it will make sense eventually.

To sum up:

Trading Styles

Scalping: Holding positions for seconds to minutes only

Day trading: Opening and closing positions in a day, with no overnight trades held

Swing trading: Holding positions for a few days

Position trading: Holding positions for weeks to months and possibly years

Many people think trading requires you to be looking at the markets 24/7, this is a terrible misconception. Unless you are a scalp or day trader, you do not need to be looking at the markets all day long.

If you are trading stocks as a swing or position trader, you could do research on weekends or for a few hours after work. Once you have entered your positions, you would only need to check up on them once a day or once a week, to manage them.

What Assets can you trade?

Stocks, ETFs, Currencies, Cryptocurrencies, Oil, Gold, etc.

How much money should you start with?

This depends if you are trading or investing.

If you want to lean more towards trading, I recommend you start with a demo account for at least 3 months. After you have perfected your trading strategy, start with a small amount and build up. Many people demo trade for a week and they make loads of money and they think they’re the wolf of wall street. When they switch to a real account where real emotions are involved, things get sticky.

Discipline, patience, composure, resilience will serve you well in the art of trading.

With investing, as this is a long-term approach and the mechanics are different with trading, I would suggest using money you are happy to lock away for a few years in order to ride the bumpy rides in the market.

However, you do not need to be constraint to being one or the other, you can hold long-term investments and also trade or find a sweet spot between investing and trading.

To summarise:

Investing is a long-term approach – time horizon is typically several years plus. The aim is to profit from long-term capital gains (increase in the value of assets invested) and there is a greater focus on asset fundamentals.

Trading is a short-term to medium term approach – time horizon can range from seconds to months. Depending on your trading style, your aim maybe short term frequent profits. Traders take advantage of fluctuations in asset prices by Buying and Selling.

In the next release, we shall cover an intro into technical analysis, the study of charts. This helps you get good entries on your trades or investments and it is imperative you master this before you start investing or trading.

It would also be a good idea to start following the markets, I recommend CNBC, Bloomberg, Yahoo finance, etc.

– Adonis

Disclaimer: The information contained in this blog is purely educational and does not constitute as investment advice. Any commentary provided is the personal opinion and philosophy of the author. It is not intended nor should be considered as invitation or inducement to buy or sell any securities noted within. Investing and trading carry significant risks, please contact a financial professional before making any investment decisions.