Anyone who wants to create wealth from the stock market would have heard the two key terms used by stock market experts: investing and trading. Suppose you are new to the stock market. In that case, you should understand the fundamental difference between the two terminologies before you decide whether you want to invest, trade, or do both in the equity market. Both methods have great opportunities as well as risks in terms of making money. This article will help you understand the key differences between investing and trading.
Before diving into the differences, let us understand the meaning of investing and trading from an analogy. Trading is like buying one kg apple from a farmer for Rs. 100 and selling them in the market for Rs. 200 to make a profit. Investing is like sowing apple seeds, growing an apple tree, waiting for years before the apple tree reaps apples, and then selling the bunch of apples in the market every year to earn profits.
With that analogy in mind, let’s examine the five key differences between investing and trading.
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Technical vs. Fundamental Analysis:
Trading involves more technical analysis skillsets, i.e., understanding how to read price and volume charts, stock price moving averages, trends, chart patterns like the cup and handle, hammer, hanging man, etc. Based on the technical analysis, traders try to time the market to buy the stock at the best possible low price and timely sell the stock when they get the highest possible price in a given short period. Traders focus on the short-term performance of the business. To time the market perfectly, traders often use algorithm-based trading using services like Robomarkets.
On the other hand, investing is like an art that involves broadly understanding the macro-economic scenario, fundamentally analyzing the value of the business, and predicting broad demand and supply trends in that company’s business in the long run. Fundamental analysis for an investor involves years of practice, and the focus is on the long-term performance of the business and not timing the market.
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Time Horizon:
The most fundamental difference between investing and trading is the time horizon for allocating your funds to a stock. Trading is generally done on a short-term basis. Traders buy a stock believing that the stock price will increase over a few hours, a few days, or a few months, and once it achieves a certain price level, the trader settles the trade by selling the stock and exits by making either a profit or loss and to manage all these processes on the automated way users can use best app for algo trading. Investing is more long-term, where an investor buys a stock based on the business’s intrinsic value. They assume an expected return on investment over a few years, hold the stock for a long time, and sell it when it has delivered the expected return. The investor is rarely worried about any short-term fluctuations in stock prices; Buy and Hold is the mantra.
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Key Decision Input:
The primary inputs that make you decide whether to trade or invest are different. For trading, price is the primary decision variable. Traders spend hours understanding the technicalities of stock price trends and buy the stock when they feel that the stock price is low and is moving upwards. They also sell the stock purely based on a target price which they would have calculated based on the technical analysis. For investing, the fundamental value of a business decides whether an investor would invest in a stock or not. A business’s value comes from the attractiveness of the industry or sector where the business operates, the ability of the company to deliver consistently higher returns than the cost of capital, the ability of the management to manage working capital efficiently, and the sustainability of the business in the long-term. If investors feel that the business will grow in value, they will buy the stock and hold it until it exhibits increasing value. If the investor suspects any decreasing trend in the fundamental value of the business, they will sell the stock.
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Risks:
Trading involves using your capital for the short-term in anticipation of profits. Therefore, there is a higher risk in trading because you can lose out your funds quickly if business performance or stock price deteriorates in the short term, giving you no time to recuperate your losses.
Investing also has risks in loss of earnings if you invest in a fundamentally bad stock. Still, since the inherent decision is based on the long-term value of the business, even if the stock prices fall, you have a more extended period to recuperate from your loss by holding the stock when the company rebounds.
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Rewards:
In terms of the rewards, trading can give you quicker profits and hence more visible returns. Your money does not compound, and therefore the rewards are usually small as a percentage of your capital.
Investing is a long-term game, and while there is no immediate access to your capital, your invested capital undergoes compounding. Hence, the rewards are higher as an absolute percentage of your initial money.
Conclusion:
To summarize, investing and trading both have great wealth-generating potential, and you can get the best of both worlds in your portfolio by taking both short-term traders and long-term investments. However, analyze the risks in any investments or trades and take the call based on your risk appetite only.
