Blurred Lines: The Difference Between Trading and Investing
Trading and investing are very different strategies, and it’s important to understand the principles of each. While both may be incorporated in an investor portfolio, they have separate objectives and distinct roles to play.
The Characteristics of Trading
The key thing to remember when differentiating between trading and investing is the goal of the action. When trading, the goal typically isn’t to hold a stock for years and benefit from appreciation. Rather traders seek out short-term gains and aim to take advantage of quick drops and spikes in prices.
There are different styles of trading such as day trading, where positions are typically only held for a day at a time. Then there are also longer-term styles, such as swing or position traders, where they may hold investments for a few weeks to years. Trading requires just as much research and knowledge as investing – it’s just deployed somewhat differently.
Traders are trying to understand and predict where a stock’s price will be at a given point. To do this, they often use technical analysis, such as price history, to look for trends in the market. Since prices are constantly changing, depending on the type of trader, they must act quickly to scoop up potential profits.
How Is Investing Different?
Investors tend to take a long-term approach to the market. Rather than trying to capitalize on very short-term opportunities, investors are buying stocks or funds whose fundamentals they have researched thoroughly. They create an asset allocation, and then select investments that may follow a ‘buy and hold’ strategy that will be appropriate for a place in a long-term asset allocation. Investing aims to create wealth over many years through the power of compound interest and long-term growth of the market.
When taking a long-term approach, day-to-day fluctuations in the market don’t have as much of an impact as they do when trading. The reason is that depending on an investor’s time horizon, it may be years or even decades before the price of the investment appreciates to the top of the projected range. Not to say that investors don’t cut their losses, because that’s an important part of investing, too.
Deciding Which Strategy to Follow
When deciding whether to trade or invest, it’s important to first know the goals for wanting to put money in the market. Is the goal to save for retirement or other long-term goals? To try and turn a quick profit? Knowing the end goal will help determine which approach is right.
It’s also important to take tax consequences into consideration. When taking a short-term trading approach, short-term capital gains come into play. Short-term capital gains are taxed as ordinary income while long-term capital gains are taxed at a much more favorable rate, currently capped at 20%.1
It can be easy to get caught up in the buzz around the latest hot stocks. However, frothy markets come and go – and sometimes very quickly.
The Bottom Line
While there’s risk any time money is put into the market, it’s important to determine investment goals and purpose, as well as risk tolerance. There may be a place for a small amount of speculative investments or trading strategies in an investment portfolio – and a booming market is good time to try that out – but it’s important to be very careful that a short-term strategy won’t derail long-term goals.
1. Ashford, Kate. What Is The Capital Gains Tax Rate? Forbes Advisor. February 12, 2021.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
Andrew Comstock, CFA
Principal - Wealth Advisor