Trading vs. investing: What’s the difference?
Sept. 16, 2020 • 7 min read
What we'll cover
Different trading strategies
How investing differs from trading
Your opportunities for trading and investing
Two runners sign up to run a race. One runs at a consistent, comfortable speed all the way to the finish line. The other alternates between bursts of sprinting and periods of walking. It’s hard to predict who will win — much like it’s difficult to say which approach, between trading vs. investing, will put investors on top.
Just as sprinting and jogging are two forms of running, trading and long-term investing are two approaches to investing money in the stock market with the intention of generating returns. While the terms are often used interchangeably, trading and investing are considerably different methods: Trading focuses on short-term buying and selling, while investing involves buying and holding securities for an extended period of time.
Depending on your level of market expertise and the time you have to spend participating in the market, neither of these methods is necessarily better or worse than the other. Learn more about both trading and investing so you can decide which tactic is most suitable for you.
Trading is all about making frequent, short-term transactions with the goal of “beating the market,” or generating greater returns than you’d expect to receive by buying and holding over a longer time frame. Whereas long-term investors may aim for a 7% annual return each year, a trading goal may be a 5% gain every month.
In the case of trading, short-term can range from immediate transactions (i.e. buying and selling a stock within minutes), up to transactions that last weeks or months. Traders buy and sell stocks , commodities, Forex, and other types of easily liquidated securities. The length of time between buying and selling a security is known as the holding period.
Types of traders
Traders are differentiated by their trading style and the time period in which they typically hold their securities:
Position: A position trader holds securities for months or years.
Swing: Swing trading involves holding securities for days or weeks.
Day: A day trader will hold a security throughout the day, but not overnight.
Scalp: Scalp traders hold securities for just seconds or minutes.
The term “buy low, sell high” comes into play often when trading, as traders aim to turn a profit in a short period of time, by closely monitoring price changes. Active traders often use technical analysis to study stocks and forecast trends in stock price fluctuations. This involves considering a stock’s technical factors more than the company’s long-term potential profits or larger economic changes.
Another common strategy for traders is short selling, which would be the opposite of the phrase we recently mentioned. When short selling a stock, traders aim to sell borrowed shares at a high price, and then purchase them back later on for a lesser amount — generating a profit through the difference in prices.
Traders often make use of limit and stop orders to help dictate the price at which stocks will be bought or sold. For example, a limit order can ensure a stock will only be bought or sold if the price reaches a certain point or better, from the perspective of the trader entering the order. A sell stop order can trigger the sale of a stock if its price reaches a specified point below the current price. A stop-loss order will trigger the sale of a security, but only if the price falls below a certain amount and remains above another specified amount. These types of orders give traders more control over the price and time at which their trades will be executed.
Is trading right for you?
Trading offers the opportunity to actively participate in the market, far more frequently than you would investing. If you enjoy the process of researching stocks and are comfortable with taking calculated risks as you closely navigate the market, you might incorporate elements of position, swing, or perhaps some day trading into your overall investment strategy.
If you are interested in taking control of your portfolio and trying your hand at trading to boost your monthly returns, you might consider opening a Self-Directed Trading Account with Ally Invest, where you can trade stocks, ETFs, and options with little to no fees. And should you trade wisely, stick to a plan to limit your losses, and are successful in your endeavors, your portfolio could be the beneficiary.
Before you begin trading, however, understand that any short-term trading strategy comes with considerable risk of loss, and positive returns are never guaranteed.
It’s also no secret that trading can be time consuming, especially scalp or day trading. Active trading requires a lot of time spent researching companies and stocks, as well as staying up-to-date with and managing your portfolio. Having a sufficient amount of time and developing experience in the market are critical components to any trading strategy. Ultimately, you may decide that you don’t have the time to dedicate toward being an active trader.
Investing is a strategy geared towards managing and growing wealth in the market over a longer period of time — we’re talking years or even decades. This means buying securities with a long-term outlook in mind and holding them through both market ups and downs until you reach your financial goal or are near the end of your investment time horizon.
Many individual investors invest in the stock market using an IRA (Individual Retirement Account) or 401(k) account to save for retirement. With these types of accounts, you might not be actively checking your account every day (perhaps even monthly) or making changes to the securities you own. Instead, you’ll likely contribute to them over a lengthy time frame, investing and potentially generating returns.
You might also invest in a personal investment account, whether through a Robo Portfolio or Self-Directed Trading (a.k.a. DIY trading), in order to grow your personal wealth or save for another financial goal, like buying a home or taking a vacation around the world.
Patience can be a virtue when it comes to investing. Successful investing strategies tend to develop over the long run and, as an investor, you may need to wait many years to realize the best potential returns. However, the longer your money is invested in the market, the more opportunity you have to capitalize on compound interest or returns.
Think of it this way: If you invest $1,000 and earn an average of 7% annually, after one year you will have $1,070 — a gain of $70. After two years, that will grow to about $1,145, a gain of another $75. Keep your investment a third year in the market and if you earn the same 7% return, you’ll be at $1,225, up $225 since you started investing. Without even adding to your initial capital, compounding allows your gains to continue growing year after year.
Keep in mind, annual returns fluctuate and there is no guarantee you will generate a positive return every year. While one year you may receive a 7% return, you very well could experience a negative return the following year, due to market volatility. It is important to understand all investing activity involves risk of loss.
Along with patience, comes the diligence of sticking to your investments even when the market experiences volatility. You may feel a temptation to sell your securities when news headlines signal a downturn, but making investment decisions based off of emotions can be detrimental to your portfolio in the long run. By avoiding emotional investing and keeping your eyes ahead, you can ride out short-term ups and downs and potentially take advantage of the market’s historically upward trajectory.
One of the most important strategies for keeping your cool while investing and setting your portfolio up for future success is diversification. A diversified portfolio consists of a mix of investments in different asset classes, industries, and geographies in order to maintain a level of risk you’re comfortable with. By spreading out your investments, you ensure you aren’t too heavily reliant on one area in the market.
Does investing make sense for you?
Unlike trading, investing doesn’t require you to constantly monitor your portfolio or the market. Once you have established your asset allocation and feel comfortable with your regular contributions, you may only need to check in on your account a couple times a year to make sure everything is on track. That said, you also don’t want to forget about your investments completely. It can be a good idea to set a regular schedule for reassessing your portfolio.
Investing can also require some heavy lifting up front to make sure you’re putting your investments into securities that have a strong chance of doing well in the long run. It’s important to know that while returns are never guaranteed, using fundamental analysis to study a stock’s value, based on the company it represents, as well as the economy, can help you make wiser investment decisions.
The good news is, if this sounds overwhelming, you can take an even more hands-off approach to investing. With our Robo Portfolio , we’ll help build you an investment portfolio that matches your goals, risk tolerance, and timeline. All you have to do is share that info with us, and we’ll select a range of diversified securities for you. Plus, we use robo-advisor technology (and our human expertise) to regularly keep tabs on your investments and to ensure you stay on track.
Long-term investing and trading are two different methods for approaching your ultimate financial goal. Whichever strategy you use depends on whether you like to get into the day-to-day (or even minute-to-minute) ups and downs of the market or prefer to ride those long-term fluctuations — neither is right or wrong! As long as you have a goal in mind, plan in place, and the patience to get there, you can use trading, investing, or a mix of both to make the most of your portfolio strategy.
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