What's the difference between trading and investing?
When somebody wants to enter the financial markets, they will usually take one of two routes: trading or investing. These are rather different approaches with unique aims and complexities, yet they are often assumed to be one and the same. And if you’re interested in trying to grow your money, it’s crucial you understand what separates these disciplines before committing your own funds. Here, we break down the differences between trading and investing to help you make the right decision for your personal situation.
What is trading?
Trading refers to the act of speculating on short-term price movements. That could be a stock, a currency pair on the foreign exchange, or the value of a commodity such as oil or gold. You hypothesise which way you believe a particular market is going to go and either buy the asset if you think it will rise, or sell if you predict a fall. If your speculation is correct you will make a profit but getting it wrong means you will suffer losses.
As trading is all about responding to short-term market changes, traders have to be proactive with their money and understand their chosen asset. The fast-paced nature of the industry means that profits and losses can accumulate very quickly, so traders should never speculate with money they can’t afford to lose and must also properly educate themselves in order to manage the risk as best they can. This is why it’s a good idea to choose a platform dedicated to helping newbies. As trading services provider Trade Nation states in guide on how to start trading: “There are a lot of trading platforms out there to choose from, but they aren’t all invested in helping beginner traders take those first all-important steps. When you’re starting out, the best platform will be the one committed to furthering your education and supporting you every step of the way.”
Generally speaking, traders hold their position for short periods of time, although some may not exit for months or even years. Overall, the aim is to be agile and make relatively frequent transactions in order to generate greater profits compared to long-term investments.
What is investing?
Investing is a much more passive approach to growing your money. Rather than buying and selling in quick succession, this involves buying and holding a portfolio of assets such as stocks, mutual funds and bonds for an extended period of time. One example of this could be a self-invested pension fund, where money is regularly paid in and left to accumulate and grow over several decades.
While trading means quickly responding to market movements, investing is about riding out periods of volatility in the hope that any losses will be recovered in the long-term. Pension funds suffered their worst quarterly performance on record between January and March 2020, which isn’t surprising given the huge economic turbulence we saw at the beginning of the coronavirus pandemic. The average UK fund lost 15.2%. However, as investment time horizons are generally in excess of 3 years, the signs of recovery in the second quarter go some way towards compensating investors over the long-term.
That said, while investing is typically less risky than trading, annual returns will still fluctuate and could result in unexpected losses. Therefore, it’s still very important for you to understand all the risks involved.
Is trading or investing best for me?
First you need to decide whether you actually want to participate in the financial markets at all. For example, if you would be uncomfortable losing any money along the way, you may be better off paying into a regular savings account. Interest rates are extremely low at present - and have been for over a decade - so you won’t see much growth, but you won’t experience any losses either.
If, however, you’re keen to see returns on your investment, the choice between trading and investing mainly depends on three things: time, risk and profit margin. Trading means making smaller, more frequent transactions for faster profits, which may be preferable if you want to see growth quickly. That said, while it is possible to achieve significant monthly returns by day trading, remember you are highly unlikely to profit every single time, so going after regular profits may also result in more regular losses. Also bear in mind that you’ll spend significantly more time trading as you’ll always be on the lookout for opportunities to enter and exit positions. But if a long-term, hands-off approach to your money is more appealing, consider building an investment portfolio instead.
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