A couple of days ago I happened to cross paths with an old acquaintance. The usual pleasantries and small talk eventually landed us on the topic of stock markets. The gentleman couldn’t stop boasting about the insane amount of money he was making and how his returns tripled in a small span.
Starry-eyed, I nodded in appreciation but deep down couldn’t help but feel a bit jealous, desperately fighting back the urge to try my luck… and why not? I mean who knows goddess Lakshmi may bestow upon me her grace and I might just be able to rake in profits too; in fact, I even started fantasizing about the various creature comforts I would be able to afford once I become the next stock market mogul!
Knowing nothing about the stock market I googled “ top stocks to invest in”, and jumped headlong with Rs 10,000. I was in for a rude awakening when my trade halved within a week. Disappointed you ask? I was devastated!
Turns out, there are many in the same boat as me. Millions of retail investors have tried “ trading” in the stock market and lost their money and mojo both. So what is it that I and many others should’ve done differently?
It all boils down to the inherent difference between trading and investment and the various aspects of these approaches. I will cover in detail four differences between investing and stock trading and which approach is better suited to retail investors. Read On!
In this article
Trading Vs Investing: Difference Based on Approach
Methods: The first difference between trading and investing is in the approach both these methods employ to make money from the stock market. Traders use technical analysis to base their buy and sell decisions where as investors use fundamental analysis.
Fundamental analysis focuses on the company’s finalysis, analysis of the industry in which the company fits in and the general macroeconomic situation in the country.
The analysis consists of studying the financial health of the industry and the company and the future growth prospects whereas technical analysis uses charts instead of annual reports and charts and patterns.
Technical analysis does use the market price of the stock to predict future patterns and analyse historical ones but does not concern itself with analysing factors affecting market price. It studies trends in price, volumes and moving averages over a period of time.
A trader doesn’t concern himself with what the company does, or what the company’s future growth prospects are.
This is a key difference between trading and investing. Trading involves more technical analysis whereas fundamental analysis is more essential in investing.
Trading involves identifying market trends and then quickly buying or selling stocks to book profits. Investing, on the other hand, is based on buying stocks of a company after carefully analyzing the business of a company.
Stock investors select fundamentally strong companies and invest in them for the long haul; as the business grows so does the value of their stock. For a stock market investor, short term market volatility is of no significance.
Also Read : How To Identify Multibagger Stocks In India
Difference Based on Time Horizon
The difference between investment and trading can also be based on time horizon. Let’s understand this with an example. Suppose you have money and you buy a house in a good locality. Within two weeks the price of your property increases and you sell it for a profit.
This is called trading. However, if you purchase a property because you know that it has immense long term appreciation potential since a national highway will be built near it a few years down the line, and hence hold on to it then you are basically investing.
Trading basically means holding stocks for a short period and making a profit by selling stocks as soon as the price touches a high. The period of consideration for traders can range anywhere from a day to weeks to months.
Many traders may buy stocks in the morning and sell by the end of the day even! Market fluctuation has very high importance and influence on the decisions a trader takes. Investing, on the other hand, is done with a long term perspective.
A stock investor selects stocks based on strong fundamentals and once convinced holds on to them for a longer period of time, ranging from a few years to decades, to even more.
Difference Based on Risks Involved
Whether you trade or invest, your capital is at the mercy of markets and hence there is a risk-return tradeoff you should be aware of. However when it comes to investing vs trading on the basis of risk, trading ranks higher.
The simple reason why trading is riskier is that trading involves taking super quick short-sighted decisions, which may go well and go horribly wrong as well.
A trader does not base his decisions on how promising the growth prospects of a business are. He may buy a scrip based on external influence and lose money when the prices hit a low which can also make it riskier.
Needless to say, trading can oscillate between highs and lows quite rapidly. On the other hand, Investing as a habit takes time to develop and reaps results in long term.
The risks are lower and comparatively the returns are lower when the period of holding is less, however, if stocks are held for a long time, your investment can fetch higher returns due to compounding effect of interest and dividends.
If the stock you have invested in is fundamentally strong, the daily market fluctuations will have negligible to no impact on your investment.
Difference Based on Attitudes
The final difference lies between the personality or wealth creation attitude of an investor and a trader. Let’s see the main differences below:-
|Trader (Buy and Sell)||Investor ( Buy and Hold)|
|A trader is of an impatient personality ( Hare)||An investor is slow and steady in approach ( tortoise)|
|Trader takes decisions within minutes, days, weeks, months||Decisions are based on long term consequences hence range from years to decades.|
|Times the market ; missing the right time to enter or exit may lead to loss||Do not time the market or get bothered by short term market volatility.|
|Stocks selection strategy based on technical analysis; momentum trading||Stock selection strategy based on fundamental analysis of a business ; value investing|
|Requires real-time data and information to take buy and sell calls hence is on his toes all the time||Is of a more relaxed disposition, information only regarding fundamentals needed.|
|Does not pay attention to what the company does and only focusses on the scrip price and trade volume.||Bases all decisions on the conviction he has on the company’s growth prospects|
|Has more risk appetite with a penchant for short term gains||Possesses lesser risk appetite comparatively, invests for the long haul|
|Is more likely to buy stocks based on recommendations by friends , other stock market traders, media and other external resources||Invests only when his investment objective aligns with a business. Does his own research, and invests only after he completely convinces himself of the potential of a business.|
Which is Better Suited for a Retail Investor?
If you look at the difference between trading and investment you will be able to see that investing approach is more suited to retail investors who want extra exposure to equities.
The advantages that accompany a stock investing mindset are numerous. All you have to do is base your bets on a business that is strong in its core offerings, is constantly innovating and adapting to customer requirements and has a solid management team backing it.
Once you are sure of this, you just need to “ buy right and sit tight”. When it comes to investing vs trading none of them have a guaranteed formula for making money in the stock market.
An investment approach will ensure success in a longer period of time. It will also allow you the much-needed peace of mind that traders never get in there attempts to time the market.
So analyze a company fundamentally, invest in the business, remain unperturbed by the market noise and stay invested to reap long term benefits.