Trading vs. Investing

investing
December 26, 2020

Trading and investing are two approaches to making money in the financial markets. The main difference between the two is the duration for which assets are held, and what buy and sell decisions are based on. With investing, assets are held for a long period of time with the goal of gradually building wealth. Trading, on the other hand, involves much shorter holding periods that aim to profit from short term fluctuations in prices.

Investing

Investing involves holding assets for a long period of time, ranging from months to decades. Investors build diversified portfolios designed manage risks according to their investment goals.

There are different strategies for choosing and buying assets, but the focus is on long term prospects instead of short term price moves. For example, with value investing, the investor buys undervalued stocks based on financial data. Another approach is to buy assets such as ETFs or mutual funds periodically without any active management on the investor's part. ETFs and mutual funds provide easy diversification since they are single investment vehicles that hold a variety of or a large number of assets.

When the investment portfolio is sometimes rebalanced when it deviates from the target asset allocation due to market developments. Rebalancing involves selling assets from an asset class that exceeded the target allocation, and using the money to buy more of another asset class to restore the balance.

Trading

The assets are held for a short timeframe with trading, which could range from minutes to weeks. The buy or sell decisions are made on the basis of news or technical analysis. For example, traders can make short term predictions based on analyzing the latest market news, or based on analyzing price charts and patterns in price movements. Trading involves much more speculation than investing, since investors mainly focus on long term prospects and on asset allocation rather than short term price fluctuations.

The holding period depends on the trading style and strategy. The table below lists the three most common trading styles.

Trading StyleHolding PeriodStrategy
Swing TradingDays or weeks.The goal is to capture short term trends in the market.
Day TradingHours. Each position is opened and closed in the same day.Make predictions based on news, or try to capture a trend, like in Swing Trading.
Scalp TradingSeconds or minutes.Trades are usually executed algorithmically on the basis of price patterns.

When trading costs and taxes are taken into account, frequent trading can become expensive due to trading costs per trade, and capital gains tax on any profits.

A common rule of thumb in trading is to never risk more than 5/% of your trading capital at an given time. This reduces the risk of loosing a large chunk of your capital when you experience successive losses. With investing, on the other hand, it is more common to have a most of the available capital allocated throughout the investment horizon.

Trading vs. Investing. Which is better?

Trading is riskier that investing due to its speculative approach and (at best) limited diversification. For most people, investing is the way to go.

Numerous studies found that most traders lose money:

"We find that 97% of all individuals who persisted for more than 300 days lost money."

Study of 1,600 day traders


"Consistent with prior work on the performance of individual investors, the vast majority of day traders lose money ... the results of our analysis suggest that less than 1% of day traders (1,000 out of 360,000) are able to outperform consistently"

Another study


It should come as no surprise that investment advisors usually recommend avoiding trading altogether and stick with long-term investing. If you choose to try your hand at trading, it is best to approach trading with extreme caution and with only a small amount of play money that you can afford to loose.

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