Trading vs. Investing: What You Should Know
In the world of investing, everybody is a trader and an investor.
The words are largely interchangeable: Both describe people who invest their money in stocks and other investments with the goal of making a profit. Whenever you buy or sell an investment, you’re making a trade.
But there are some key differences between trading and investing, and understanding those differences can help you clarify where you stand, and what your overall investment goals are (as we note in the article how to invest, knowing your goals is a crucial first step to successful investing).
- Traders seek to make money off of price fluctuations, buying and selling shares over the course of minutes, hours, days, weeks or years. Their goal is to outperform average market returns. Shorter-term traders generally are less interested in the long-term prospects for a company’s success, and are more focused on what the company’s share price is doing and how market conditions might affect that share price.
The differences between types of traders come down mainly to timing. For example, day traders buy and sell over the course of a day, swing traders might hold an investment for a few weeks, and position traders think in terms of months or years.
- Investors, in contrast, focus on building a diversified investment portfolio that they’ll hold for years, even decades, riding out any market volatility as they stay invested for their long-term goals — hence they’re often described as “buy and hold” investors. Generally, they hope to match the returns of a benchmark index.
Another way to think about the difference between investing styles is active vs. passive:
- Active investors, like traders, take a more hands-on approach to investing, conducting research and trading in and out of investments based on what they know about specific stocks or sectors, or their sense of where the market’s headed next, with the goal of exceeding market returns.
- Passive investors focus on building a low-cost, broadly diversified investment portfolio and then letting it sit over time, reinvesting dividends to help their money grow for a long-term goal, such as retirement, with the goal of matching market returns.
Trading vs. investing
|Trading (active investors)||Investing (passive investors)|
|Goal||Traders seek to outdo average market returns by profiting on mispricings in share prices; they often focus on technical factors, stock-market patterns, market conditions and/or companies’ fundamentals and prospects.||Investors seek to balance risk and potential return with minimal time commitment through a low-cost, diversified investment portfolio, often made up of index mutual funds or ETFs, held for years or decades.|
|Timeframe||Can range from extremely short-term, trading in and out of investments within minutes, hours, days or weeks, to long-term, holding investments for years before selling.||Very long-term, buying and holding for decades.|
|Risks||–Traders might choose the wrong investment to buy or sell at the wrong time, leading to losses.
–A focus on individual stocks makes it hard to diversify, increasing risk of investment losses.
|–Investing in the stock market brings risk of investment losses if forced to sell when shares have dropped in value.
–Failing to match investment portfolio to risk tolerance can lead to selling when the market falls.
|Pros||–The prospect of beating average market returns.
–The challenge of trying to outsmart the market.
–Ability to manage the timing of capital gains and losses for tax efficiency.
|–The likelihood of building wealth over time.
–Low time commitment.
|Cons||-Complicated and time-consuming
–Pricey (trading costs, research costs, etc.)
–Taxes (likely to pay income-tax rates on short-term gains)
|-Unlikely to beat average market returns.|
Learn how to trade
Be sure to read more about how trading works, here and on our sister site StockBrokers.com:
- Check out 10 great ways to learn stock trading
- Don’t miss our reasons to avoid day trading
- See the best brokers for stock traders
- Learn more about how to invest
If you want to try trading without worrying about losing your shirt, pick a broker that offers paper, aka virtual, trading. It’s a great way to test your skills without risk.
Are you a trader, an investor or maybe both?
Here are three questions to help you decide whether you’re a trader or an investor. You can also choose to be a bit of both, using some money to trade and other money to invest.
What is your goal for this money?
- If you want to dive into the stock market in a hands-on way and you understand that you might lose money, then trading might well be for you. It’s a great way to start learning how the financial markets work, and you might even make some money.
- If your goal is earning money for a long-term goal like retirement, then your best bet is to build a diversified portfolio of low-cost investments that you hold for the long haul. Check out our story on how to invest for retirement.
- If you’re going to need this money for a specific goal sometime in the next five years, maybe skip investing altogether and park your money in a high-yield savings or money market account. Check out our story on the best high-yield savings accounts.
How involved do you want to be?
Put another way: What’s your risk tolerance?
- If the thought of watching your investments drop in value panics you, then trading likely is not for you. That said, investing for a long-term goal like retirement can be a great way to maximize your returns. Just be sure to consider a moderate or conservative asset allocation to reach your goals.
- If running with the bulls in Pamplona is your idea of a walk in the park, you drink coffee by the gallon, and you’ve got extra cash to burn, then you’ve got all the hallmarks of a day trader. Go for it, as long as you go in with a plan for how much money you’re willing to spend — and possibly lose.
How’s your overall financial situation?
The prospect of making a bucketload of money as a trader is an appealing one, no doubt. But before you start sending your money in that direction, take stock of where you’re at.
- Do you have an emergency fund with three months’ worth of essential expenses? If not, consider focusing on that goal first. Be sure to stash your cash in one of our top-rated high-yield savings accounts.
- Do you have credit card debt? Focus first on getting that paid down before you throw money into trading. Here’s more on how to get out of debt.
- Are you investing for retirement? If you’ve got a retirement plan at work, consider maxing it out before you start trading. If you don’t have a workplace plan, consider opening an IRA.
Is investing better than day trading?
The answer to whether investing is better than day trading will depend on your goals and mindset. If you have time, energy and interest in tracking economic and market news on a regular basis (daily if you’re day trading), then trading can be a fun, exciting and challenging way to make money.
Keep in mind there are upfront and ongoing costs to consider with trading, including trading fees, research and subscription costs, and more. Proceed carefully, and first things first: Read the stock market education guide. Go in with your eyes open, and understand that you might lose money, too.
If you’re unable or unwilling to spend the time and energy researching the market and individual investments, then passive long-term, buy-and-hold investing is better than day trading. It’s less risky, less expensive, and less of a time suck.
Is trading stocks a good idea?
Whether trading stocks is a good idea will depend on your financial goals and situation. If you have time, energy and money to spare, then trading stocks could make sense for you. Just keep in mind that it’s hard to build a diversified portfolio by buying stocks of individual companies. On the other hand, if you buy shares in just one ETF or mutual fund, you could be instantly diversified (assuming the ETF or mutual fund invests in hundreds or thousands of companies), and thus spread your risk over many companies and possibly industries, too.
Can day trading make you rich?
Sure, day trading could potentially make you rich. There’s certainly no shortage of social media hype promising this is true. But it’s not a surefire path to quick riches. You really have to know what you’re doing. Seriously. Go in with your eyes open. Check out our free guides on Stock Market Education, including 10 reasons to avoid day trading.