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Investing vs Trading
‘Investing’ and ‘trading’ are frequently used interchangeably. There are, however, significant differences between the two financial strategies. The goal of investing is to accumulate wealth over the medium to long term. Trading, on the other hand, seeks to generate profits in the short term. This guide examines the fundamentals of investing and trading and explains how the two financial strategies differ.
Check out our related post What Is Defensive Investing?
A Detailed Guide to Investing vs. Trading
What is Investing?
Investing is a “buy-and-hold” strategy for the long term. Investors will frequently hold assets for years, if not decades, with the goal of profiting handsomely from rising asset prices and any income generated by the assets over time.
The exact time horizon (the length of time that an investor expects to invest for) of an investor is determined by their financial objectives. Someone investing for retirement, for example, may have a time horizon of 20 years or more. Someone investing for a down payment on a house, on the other hand, may have a time horizon of five years.
A fundamental principle of investing is that the greater an investment’s potential return, the greater its risk. This is referred to as the ‘risk-return tradeoff.’ The possibility that an investment’s actual returns will differ from its expected returns is referred to as risk.
The longer an investor’s time horizon, the more opportunities for higher-growth, higher-risk investments there are. This is due to the fact that they have more time to weather market volatility. An investor with a shorter time horizon must be more conservative in their investment choices or risk failing to meet their financial objectives.
Most investors are at ease with the fact that financial markets fluctuate in the short term. As a result, they will frequently ride out periods of underperformance in the hope that asset prices will eventually recover and any short-term losses will be recouped.
Investing Styles
Investing can be classified into two types. They are as follows:
Active Investing
Active investing entails actively buying and selling securities for the purpose of outperforming an investment benchmark index over time. An active stock market investor, for example, might purchase 30 individual stocks in order to outperform the S&P 500 index (a stock market index that is composed of 500 large US companies).
Passive Investing
Passive investing’s goal is to simply match the performance of a market or benchmark index over time. Investors do not select individual securities for their portfolios under this strategy. Instead, they invest in benchmark-based funds, such as exchange-traded funds (ETFs) and index funds, which seek to replicate market performance.
What is Investing
Trading, as opposed to investing, is a more active, short-term strategy.
Traders hold assets for much shorter periods of time than investors, frequently buying and selling securities within weeks, days, or even hours in order to profit from short-term price fluctuations.
Traders seek to profit from both rising and falling asset prices, whereas investors seek to profit primarily from rising asset prices. Rather than focusing on an asset’s long-term growth prospects, traders focus on which direction the asset’s price is likely to go next and attempt to profit from that price movement.
Traders, as opposed to investors, are more likely to use ‘stop-loss’ orders to automatically close out losing trades at a predetermined price level. This helps to safeguard trading capital.
Trading generally necessitates a greater time commitment than investing. Unlike an investor, who can buy a stock or fund and then forget about it, a trader must constantly monitor market developments.
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Trading Styles
There are numerous trading styles that traders pursue. These are some examples:
Scalping
Scalping is a trading strategy that aims to capture small profits on a regular basis. It entails holding a position for a very short period of time, perhaps only a few minutes or less. Please keep in mind that this type of trading is not permitted on eToro.
Day Trading
Day trading is a trading strategy that involves opening and closing positions in a single day. Closing a trade before the market closes reduces the chances of receiving negative news overnight.
Position Trading
Position trading is the practise of profiting from dominant price trends. When the price of an asset moves in one direction for an extended period of time, this is referred to as a trend.
Swing Trading
Swing trading aims to focus on larger price movements rather than identifying the start and end of a price trend. Positions in this strategy may be held for days to weeks.
What is Social Trading?
Social trading is an innovative form of trading that is unique to eToro that allows individuals to observe and potentially replicate the trading strategies of their peers or more experienced traders.
It is one of the most visible developments in the financial industry in recent years, bringing together traders from various backgrounds and allowing them to collaborate and copy each other’s trades.
Social trading has several advantages:
It enables those with limited financial knowledge to benefit from the knowledge of more experienced traders. Beginners can learn how to analyse markets and develop profitable strategies by interacting with talented or experienced traders.
Working together and sharing ideas allows traders to potentially improve their performance.
Because everyone shares information, it can save traders a significant amount of research time.
It can be applied to a variety of asset classes, including stocks, ETFs, currencies, commodities, and cryptocurrencies.
Social Trading with eToro’s CopyTrader
The award-winning CopyTrader technology from eToro extends the social trading concept by allowing individuals to automatically replicate the strategies of top-performing traders in real time.
Anyone can trade like a top trader with CopyTrader. CopyTrader can help you trade more effectively whether you’re a beginner learning the basics of trading, an expert who is impressed by another trader’s track record, or someone who simply lacks the time to research and monitor the financial markets.
CopyTrader is simple to use: simply select the traders you want to copy, decide how much money you want to trade, and copy everything they do automatically and in real-time with a single click of a button. Furthermore, there is no charge to use this service.
Your capital is at risk. Other fees apply.
Key Differences Between Investing vs Trading
Aside from the fact that investing is more long-term in nature, whereas trading is more short-term in nature, there are numerous other distinctions between the two strategies.
Here are three key distinctions between investing and trading.
Stock Market
Stocks are the most popular asset class among investors.
Stocks, also known as ‘shares,’ are investments that represent ownership in a company.
Investing in stocks can be an excellent way to build wealth over time. Stocks have historically provided excellent long-term returns to investors.
For example, the S&P 500 index has risen by around 10% per year on average since its inception in 1926.
This is a much higher rate of return than other assets such as bonds and cash savings.
Some investors prefer to select individual stocks (such as Apple, Amazon, and Microsoft). Others prefer to invest in stocks through mutual funds and exchange-traded funds (ETFs), which provide broad exposure to the stock market.
Investors frequently add other assets to their portfolios in an effort to boost returns and reduce portfolio risk. For example, an investor may hold a mix of stocks and ETFs, as well as commodities like gold and silver and cryptoassets like Bitcoin and Ethereum.
Traders, as opposed to investors, concentrate on a broader range of asset classes. There are traders who specialise in stocks, indices, currencies, commodities, and cryptoassets, for example.
In general, traders prefer more volatile asset classes because volatility creates trading opportunities.
You can trade a wide variety of asset classes on eToro, including:
- Stocks
- Indices
- ETFs
- Currencies
- Commodities
- Cryptoassets
Traders, as opposed to investors, frequently use financial instruments such as Contracts For Difference (CFDs) to gain exposure to a specific asset class or security.
CFDs are financial instruments that allow traders to profit from the price movements of an asset without actually owning it.
They, above all, allow traders to trade in both directions (i.e. profit from both upward and downward price movements). They also allow traders to use leverage to control more money than they deposited on the trade.
For example, with X2 leverage, a trader can control $5,000 in assets with a $2,500 deposit. With X10 leverage, they can control $5,000 with a $500 deposit. The benefit of using leverage is that it can boost your profits. Leverage, on the other hand, can magnify your losses, so it’s critical to understand the risks.
Forms of Research and Analysis
Another distinction between investors and traders is how they conduct market research and look for opportunities. Investors typically concentrate on fundamental analysis.
This type of analysis entails reviewing all available information about an asset in order to determine whether to buy or sell that asset.
In the case of a stock, for example, an investor might consider the company’s recent revenue and profit growth, its balance sheet, the threat of competitors, and the economic backdrop to determine whether the stock is worth purchasing.
Traders, on the other hand, are more concerned with technical analysis.
Traders use this type of analysis to forecast an asset’s future price movements by examining price charts and analysing trends, patterns, and indicators. Technical analysis is based on the idea that past price movements can be used to forecast future price movements.
Three popular technical analysis strategies are as follows:
Trend Trading
This strategy seeks to generate profits by analysing the price trend of an asset. Once a trader has identified a trend, he or she may be able to profit by trading in the same direction as the trend.
Trading Support and Resistance
This strategy seeks to generate profits by identifying an asset’s support and resistance levels. The level on the chart where the asset’s price finds it difficult to fall below is known as support. The level of resistance is the point at which the asset’s price finds it difficult to rise above.
Once these areas have been identified, it may be possible to profit by entering trades at the point where the asset’s price is most likely to reverse.
Breakout Trading
This strategy seeks to profit by identifying assets that have breached established support or resistance levels. Breakouts can be powerful signals, especially when they are supported by other technical analysis indicators.
Risk Assessment and Risk Management
Investing and trading both carry their own set of risks. As a result, investors and traders must manage risk in different ways.
The following are the primary risks that investors face:
- Market risk is the risk that the value of an entire market will fall.
- Specific risk: the risk that the value of a specific asset, such as a stock or cryptoasset, will fall.
Diversification of portfolios can help investors reduce these risks. This is the process of spreading your money across multiple investments so that you are not overly exposed to any one asset or security.
A portfolio that includes many different stocks, a few ETFs, some bonds, commodities such as gold and silver, and some cryptoassets will have a much lower overall risk than a portfolio that only includes one stock or cryptoasset.
The following are the main risks that traders face:
- Volatility risk refers to the risk of short-term price fluctuations.
- The risk of using leverage is known as leverage risk. While leverage can boost profits, it can also amplify losses.
Trader risk management strategies include:
- Choosing the Best Position Size
- Using stop losses to reduce losses
- Avoiding overuse of leverage
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Which is Better Investing or Trading?
Investing and trading both have benefits and drawbacks.
One strategy is not superior to another. Both have proven to be profitable methods of profiting from the global financial markets.
Finally, which strategy is best for you will be determined by a number of factors, including:
- Your financial targets
- Your tolerance for risk
- Your knowledge of a specific market or asset class
- The amount of time you’re willing to devote to research and monitoring your investments.
- The amount of money you need to get started
In conclusion: Investing vs Trading
The table below summarises the differences between investing and trading.
Your capital is at risk. Other fees apply.
Ready to start trading? Open an account now. Need more time? Try a Demo here.
Please make sure to find and follow Defensive Trading on eToro for more trading insight here.
As always, if you have any questions, we would love to hear from you. Please contact us. Happy trading!
Risk Disclaimer: Please remember that this information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research.
Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.
