Trading and investing are two ways to play the stock market, each with its own set of advantages and disadvantages.

Trading and investing are two distinct ways to approach the stock market, and which is preferable depends on your time commitment and risk tolerance.
Investing is purchasing an item with the expectation that its value will grow over time, with the objective of long-term profits.

Trading, on the other hand, is all about anticipating market movements and buying and selling stocks quickly for a profit.

Stock trading has always been a popular activity, particularly throughout the decade’s lengthy bull market. However, during the 2020 coronavirus pandemic, its popularity has soared to unprecedented heights.

Many traders have become famous on the internet. Perhaps you know someone who’s gotten on the trading bandwagon, and you’re thinking whether you should join them — rather than simply putting money into your 401(k) or investing in a mutual fund every now and again.

It’s crucial to note, however, that the terms “active” and “investor” seldom go together.

The stock market may be approached in two ways: trading and investing. When you trade, you’re aiming to make rapid money off of short-term market changes. Long-term investors, on the other hand, prefer to develop diverse asset portfolios and stick with them through market ups and downs.

Many investors, particularly individuals, may desire to avoid trading because of its high-stakes nature and inherent hazards. Others, on the other hand, may want to spend a portion of their money in trading and the balance in long-term investments. Let’s take a deeper look at the fundamentals of each technique, as well as their benefits and drawbacks.

Investing fundamentals

Investing is the process of placing money into a financial asset (stocks, bonds, mutual or exchange-traded funds, and so on) that you believe will appreciate in value over time. Investors often have a lengthy time horizon and want to create money via compound interest and steady appreciation rather than short-term profits.

The narrower your time horizon, the more likely you are to lose money on your investment. That’s why the SEC’s Office of Investor Education and Advocacy advises placing money in a savings account if you’ll need it in the next three years. Investing might provide considerably greater results for all other objectives. Some investors may even want to keep their money for decades.

Diversification (having a diverse portfolio of assets) is beneficial to investors because it reduces risk, mostly by lessening the impacts of volatility (rapid, violent, or unexpected changes in values or price). Mutual funds and exchange-traded funds (ETFs) – single investment vehicles that hold a range of or a large number of assets — may now provide quick diversification to investors. When deciding on your portfolio’s asset allocation, keep in mind your risk tolerance and expected withdrawal date.

When it comes to individual stocks and bonds, investors often look at fundamental indicators, which are aspects of the issuing company’s profitability, history, or creditworthiness. These criteria aid in the identification of companies that are inexpensive (i.e. value investing) or have the potential for considerable capital growth (i.e. growth investing).

The fundamentals of trading

Buying and selling stocks or other assets in a short period of time with the intention of generating rapid gains is referred to as trading. Traders think in terms of weeks, days, or even minutes, while investors think in years.

Day trading and swing trading are two of the most prevalent types of trading. Day traders purchase and sell a security on the same trading day; they never hold holdings overnight. Swing traders, on the other hand, purchase assets with the expectation of a quick increase in value over a few days or weeks.

The fundamentals of a stock are mostly meaningless in the realm of trading. Even though a stock’s value is predicted to rise over time, it doesn’t indicate it will do so in the next few minutes, much alone days. As a result, traders prefer to base their trading choices more largely on technical analysis of market movements and news sources.

Trading may be a dangerous business. You may lose a lot of money in a short amount of time if a deal goes against you. Traders also often enhance their risk by using leverage, which is borrowing money or purchasing assets with cash they don’t have. Leverage may take the form of options, margin trading, or short selling.

The “big person” seems to be more talented and informed than the “small guy” in many cases (or gal). While some traders are better at reading charts and conducting technical analysis than others, no one can anticipate every transaction with certainty. Celebrity traders may (and do) lose a lot of money when they trade.

If you want to try your hand at trading, lower position sizes (i.e., not risking a lot of money) may help you avoid losing a lot of money on a single transaction. Setting a stop-loss order that will execute automatically if the asset falls below a specific price is another advice (thereby limiting your losses).

Is one superior than the other?

Trading and investing are two distinct behaviours with distinct goals, despite the fact that they both involve financial markets and assets. As a result, generalisations and comparisons are difficult.

Trading, on the other hand, is riskier in general for two reasons:

It involves a lot of guesswork, such as rapid judgements, intelligent estimates, and outright bets.

Because it’s impossible to keep track of more than a few deals at once, it necessitates low (or no) diversification. Furthermore, diversification’s “evens-out” characteristic mitigates both the ups and downs — and traders want the highest possible highs.

It should be emphasised, however, that trading may result in bigger profits. Investors might expect an annual return of 8% to 10% on their assets. A trader, on the other hand, would aspire to make that much or more every month. Even traders who made “just” 5% per month would have a 60 percent yearly return if they compounded their profits.

As a result, crowning either technique as the “optimal” way to approach the stock market is challenging. Investing is the way to go if you have a low risk tolerance and wish to avoid volatility. Trading, on the other hand, can appeal to you if you’re a risk taker looking for a quick way to make a lot of money.

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It’s important to realise that trading and investing don’t have to be mutually incompatible activities. For example, you may decide to put 90% of your money into a diversified portfolio that you’ll keep for the long run and use the other 10% — your “play money” — for short-term, speculative trading.

The monetary takeaway

Trading may be a fun method to make fast money. It may, however, swiftly lead to large losses, much like gambling. Investing normally entails fewer big successes in the near term, but also fewer big losses.

Trading with a part of your money may be pleasant and profitable if you’re okay with the risks. If limiting risk and exposure to volatility are your primary objectives, long-term investment is the way to go. A slow-and-steady investment technique is typically optimal if you’re saving for a financial objective that you want to achieve by a certain date.

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