Among the uninitiated, the terms trading and investing many appear interchangeable. In fact, many major news outlets will often use both words this way, even though they are actually not the same thing. The confusion comes from the fact that the two activities both involve the buying and selling of some form of financial instrument, however, this is where the similarities end.
If you’re thinking of dipping your toe into the financial markets, you might be unsure which is right for you. So to help you head off in the right direction, here is a guide to the differences between trading and investing.
Speed and Timeframes
The main difference between investing and trading is the timeframes that their respective participants take. Generally, investing is something you will do over months or years at a time to make a gain, while trading focuses on profiting from the short-term inefficiencies in the markets.
In the past, trading was something that only big institutions could do because they had access to expensive terminals, a long list of industry contacts, and the ability to execute trades quickly. For the average Joe on the street, this wasn’t possible as it would be too late by the time they had the information.
Today, however, things are very different. Online platforms have leveled the playing field by allowing consumers to get involved in online trading through their computers or mobile devices. By trading over the internet, users can open and close positions in real-time, reacting to market conditions as they happen.
On the other hand, while investors can also transact online, they may have to wait for a day before their instructions are carried out by their broker, particularly if they’re purchasing a unit trust or a similar fund.
Additionally, investors will typically be penalized for making lots of moves as fees will chip away at their profits. This incentivises investors to stay in the market for long periods of time, spanning months, years, or even decades. In contrast, traders will close positions daily and can be dis-incentivised to keep them open for long periods by rollover fees.
Owning the Underlying Asset
As a general rule, investing involves purchasing an asset or a right to an asset, while trading will not usually offer this. This is because trading will often use derivatives instead.
Derivatives like contracts for differences (CFDs) are useful to traders as they are faster and easier to buy and sell quickly while still allowing you to gain exposure to a particular instrument. They are often also cheaper to trade, which is essential if you’re making lots of moves within the market.
However, investors that own the underlying asset may also have a right to dividends or interest. For example, for every share of Coca-Cola that you bought in January 2021 and held throughout the year, you would have received $1.68 in dividends. That doesn’t sound like a lot but if you’d purchased $10,000 worth of stock, you’d have received $316 of dividends and made $1,902 of gains on the share price by December.
Dividends aren’t always a guarantee and a company’s decision to halt or reduce the size of a dividend could also result in your investment shrinking in size, so it can be a double-edged sword.
Freedom to Choose and Personal Preference
Some investment platforms may only offer you funds with a pre-selected basket of stocks. If you’re someone who isn’t interested in following the market closely, then this may be an ideal option for you.
But if you want the freedom to follow your own strategies and make decisions for yourself, then trading could be a better way to go. This is because trading platforms offer the option to go both long and short, allowing you to profit from successfully predicting an instrument’s negative outlook, and not just a positive one. They also provide tools like stop-loss and fill-or-kill, allowing you to get in and out of the market at your preferred price points.