What Are the Differences Between Investing and Trading?
What is Investing?
The goal of investing is to build wealth over the long haul — years to decades — by building a well-diversified portfolio. They may divide their portfolio into goals, with each section carrying a varying degree of risk, such as:
- Investing in retirement funds, like 401(k)s or IRAs
- Saving for a down deposit on a house or new car
- Building a college fund for themselves or their children
And, unlike trading, investors don’t sell off positions in their portfolio at the first sign of trouble — even if their portfolio takes a significant hit. Instead, they ride out the downtrends (and maybe even increase their holdings to “buy the dip”) on the hope that prices will rebound even higher on the other side.
At the end of the day, investors, unlike traders, stick to the mantra, “The market will always perform.”
What is Trading?
The goal of trading, on the other hand, is to “beat the market” — and the returns seen in buy-and-hold investing. Instead of buying long positions to hold in their portfolio, traders get in and out of positions as quickly as they can turn a profit.
For example, the S&P 500 has generated roughly 10% returns annually over the last few decades, which is the standard for many investors. But traders may seek 10% in profits every month, compounding their profits significantly.
To do this, traders take advantage of small, short-term price fluctuations — either up or down — and jump on opportunities as they arise. For instance, if political uncertainty in Europe were to raise the price of U.S.-based mining companies for three hours, traders would snap up the stock in minutes — and sell again when it showed signs of trending downward.
And instead of waiting out downturns in the market, they may initiate a stop-loss order to automatically sell their assets if the price falls below a predetermined point.
What are the differences between investing and trading?
Here are a few key differences.
As we’ve established, investors tend to hold their positions for years to decades. They may keep these in retirement accounts, college accounts, or a generic investment portfolio with a broker, but they typically don’t sell unless a once-in-a-lifetime opportunity forces their hand.
On the other hand, traders may keep their positions for days, hours, or even minutes. In fact, there are four “styles” of traders, defined by how long they hold their assets:
- Scalp traders hold positions for seconds to minutes, and never overnight
- Day traders maintain their positions for hours, though usually not overnight
- Swing traders keep their assets for days to weeks
- Position traders are the most similar to investors, as they hold positions for months to years
While neither investing nor trading has a standardized set amount to begin, laws do regulate the amount of capital you need to have for trading.
Traders use a broker to facilitate their transactions; and typically, brokers require you to maintain a daily account balance, or margin. The Securities and Exchange Commission (SEC) requires traders who trade four or more times in five days to maintain $25,000 in their margin account in order to trade.
Additionally, many brokers charge flat rate or percentage-based fees on every transaction. As such, traders can rack up charges quickly.
Depending on the broker, investors usually pay fees on their AUM (assets under management) ranging from free to 1% or more. Some investments, such as mutual funds, may also charge sales load, redemption, account, and/or purchase fees.
Traders and investors also do different types and amounts of research to prepare for their positions.
For instance, traders use technical analysis to determine which assets are worth their trading dollars. Moving averages, stochastic oscillators, and recent news reports can all inform the most lucrative trading setups.
Investors, however, usually focus on the market fundamentals underlying choice investments, such as price-to-earnings ratios, forward-facing guidance, and company history and compositions. Investors may also select worthwhile investments by whether or not they pay dividends or how often they increase their dividends.
Often times, investors and traders employ different vehicles to achieve their goals.
For example, investors tend to select funds and assets they expect to rise in price over longer periods of time. On the other hand, traders transact more frequently, and in more ways. For instance, they may jump in and out of stocks, commodities, or currency pairs at a moment’s notice. They may also invest in riskier positions that have expiration dates, such as futures and options, or frequently open short-selling positions.
Risks and Rewards
The shorter your hold time, the better chance you have of losing your investment. While investors do face some risk, holding positions for years also gives their investments a chance to regain their losses when — not if — the market fluctuates.
Investors and traders also reap different kinds (and amounts) of rewards based on their trading activities.
On the whole, investors take advantage of compounding, reinvesting profits and dividends, and gradual, long-term appreciation to growth their wealth over time. By contrast, traders try to profit by buying and selling assets quickly. They may wait for a particular stock to start rising, or they might open a short position to capitalize on falling stock prices.
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Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC (“Quantalytics”). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC (“QAI”), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai’s investment advisory services.