Trading vs investing: what’s the difference?
The terms ‘trading’ and ‘investing’ are often used interchangeably, but there are key differences between these two methods of attempting to profit from financial markets. Explore both trading and investing in our in-depth guide.
Trading vs investing: an overview
Trading and investing both involve taking a position on a financial market in order to profit from price movements. However, they pursue this goal in vastly different ways. While investors will physically buy the asset in question, traders will take a speculative position on the underlying market price.
Investors will take a longer-term look at markets, assessing the future health and growth prospects of a company over years and even decades. Traders or speculators will look at rising and falling markets over a shorter time frame in order to profit from volatility.
Basics of investing
Investing is the traditional ‘buy and hold’ strategy, in which an individual will buy an asset outright with the intention of holding it for a long period of time and selling it for a profit at a later date.
Investing is used as an alternative means of generating a return on cash. While you could let your savings sit in a bank and earn interest, you could choose to take a risk with your capital and invest. While investments can result in losses, they can also earn you a lot more than you put in.
Investment markets
The most common market for investors is the stock market, which is the exchange of shares or equities. Shares are portions of ownership in a company, so when you own a share, you are entitled to certain rights. These can include votes on a company’s decisions and a portion of the company’s earnings in the form of dividend payments – if dividends are paid by the company.
Investment methods
Most investors will use a broker to complete their transactions with exchanges and execute positions on their behalf.
Investing timeframe
Traditionally, investing has a longer time frame than trading, as it can take years for the desired returns to accumulate.
However, individual investors will have different ‘time horizons’ – which is the term used to describe how long an individual expects to hold onto an investment. These time horizons will be dictated by the individual’s chosen method of investing, their goals, and the style of investing they employ.
Initial capital required for investing
When you invest, you’ll be required to put down the entire value of the asset to open a position. So, if you want to buy five shares that are currently worth £100 each, you’ll have to pay £500 upfront.
Returns from investment
Most investors will aim to achieve returns of 10%-15% annually. There are two main avenues of profit for investors, these are:
- Dividend payments – which can be paid by companies to their shareholders, depending on the company’s performance
- Capital appreciation – which is the difference between the price you bought the asset at and the price you sell it for. This is known as return on investment, or return on investment (ROI)
Dividend payments will vary from company to company and can change throughout the year depending on a company’s performance – sometimes dividends may not be paid at all. This makes it important to read earnings announcements each quarter. Dividends will be paid directly into your account in cash.
The return on your investment will only be received once you have closed your position by selling the asset in question. Once you have sold your shares, you’ll be able to reinvest immediately or withdraw the cash to your bank account once the shares have ‘settled’. This process usually takes two days.
Cost of investing
An important thing to remember is that you’ll also need to consider the fees associated with investing – high broker fees can eat into any returns that you make. This is why it is so important to compare your broker against others to ensure you’ll be getting the best service for your money.
Taxes for investments and benefits
When you invest, your positions may also be subject to additional fees or taxes depending on the country where the company is listed. Tax laws are subject to change and depend on individual circumstances.
Risks of investing
When you invest, your risk is capped at the price at the purchase price of the asset. You won’t lose more than you paid for the asset in the first place – additional fees excluded.
Continuing the earlier example, if you paid £500 to open a position on five shares worth £100 each, and the share value fell all the way to zero, you would lose £500. This is known as equity risk.
Each investor’s level of acceptable risk is different. You should calculate your risk appetite based on your financial goals, how much time you can dedicate to portfolio management and how much capital you have available.
Basics of trading
Trading involves speculating on the future price of a market via derivative products. These products take their value from an underlying asset, and do not require a trader to own the asset in order to take a position.
Traders can not only open the more traditional ‘long’ position, but they can take advantage of markets that are falling in price too – known as going ‘short’. This opens up a whole other avenue of potential profit.
Markets to trade
When you trade, you’ll be able to take a position on a wider variety of asset classes, and you won’t need to worry about the intricacies of taking ownership of the asset – such as delivery of currencies or commodities.
You can trade a range of asset classes, including:
- Shares. When taking a position on a share, it is important to research the company, the industry and the stock exchange it is listed on. Unless your provider offers out-of-hours trading, your dealing will be confined to the exchange’s opening hours
- Indices. A stock index enables you to trade on the performance of a group of shares, rather than just one company. As there are many constituents that can move the market, stock indices tend to see more volatility than individual shares
- Forex (FX). This is the world’s most liquid and volatile financial market due to the vast number of currency dealers. Traders can buy and sell currencies 24 hours a day, five days a week.
- Commodities. Trading commodities provides vast opportunities for profit, but the nature of the market creates a high level of risk. The price of commodities can fluctuate constantly as the rate of their production and consumption changes
- Cryptocurrencies. These digital assets can be speculated on just like physical currencies. The crypto market is known for its volatility, which can create an exciting landscape for traders .
Trading time frame
Trading timeframes are significantly shorter than investing holding times – while investors will hold positions for years, traders will hold positions for just minutes, hours, days or weeks. The time frame of a trade completely depends on the style of trading you choose to use.
Whereas investors ignore smaller market movements, and focus on the longer-term trend of the market, traders aim to open positions more frequently to take advantage of volatility around key events and intraday activity.
Cost of trading
As with investing, there will be some additional charges associated with each trade. In most cases this fee is in the form of a spread, which we charge on top of the market price. The spread is the difference between the bid and ask prices and can vary depending on market conditions.
Risks of trading
While leverage can magnify profits, as we’ve seen, it can also magnify your losses. To help restrict your potential losses from trading, there are a variety of ways that you can manage your risk.
The most common are stops and limits. Stops automatically close your position when the market moves against you by a specified amount. You can choose from three types of stop:
- Basic. Closes you out as near as possible to the price level you choose. A basic stop may be affected by ‘gapping’ overnight or in times of high volatility
- Guaranteed. Closes you out at the level you requested, regardless of whether the market gaps. This will incur a small premium, but only if the stop is triggered
- Trailing. Moves with your position when the market moves in your favor, but locks in as soon as the market starts to move against you
Limits, meanwhile, do the opposite, closing your position when the market moves a specified distance in your favor. Limits are a great way to secure profits in volatile markets.
Start trading with Tokenize
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