The aim of stock trading and investing is to benefit financially from favorable movements in the price of a stock or a portfolio of stocks. However, this is where most of the similarities end. Stock trading and investing can differ greatly in terms of approach and methods. Investing usually involves the physical purchase of stocks through a stockbroking account while stock traders simply look to take a speculative position on the underlying market, which can be through the stock itself or a related derivative such as an options contract.
Keep reading to explore stock trading and stock investing differences in greater depth.
Trading vs investing: A comparison
The table below provides a snapshot of the main differences between trading stocks and investing in stocks.
|Objective||Capitalize on short term price movements||Capitalize on long term trends, dividends and company growth|
|Method||Stocks, related options or other derivative products||Share dealing or stock brokerage account|
|Time frame||Short to medium term||Medium to long term|
|Returns||Winning long or short trades*||Capital appreciation from long-term company growth and dividends**|
|Transactional costs (will vary based on broker)||
|Style||Scalping, day trading, swing trading and position trading||Active and passive investing|
|Risk||Potentially magnified by higher usages of leverage.||If not utilizing leverage, the risk can usually be limited to the initial capital outlay.|
*Returns can be positive or negative. Keep in mind negative returns are magnified due to leverage.
** Investing returns can be positive or negative. However, investor losses are capped at the amount of the initial investment plus any accrued dividends.
What does stock trading involve?
There are five key points of emphasis when comparing trading vs investing:
2) Time horizon
1) Objective (capitalize on shorter term price movement)
Stock traders usually seek to benefit from taking speculative positions while focusing on short to medium term price movements. They frequently jump in and out of stocks and look to capitalize on short-term movements in the market. For example, prolonged trade negotiations may disrupt production and sales for export firms, leading to a drop in the share price. As this information is being ‘priced-in’ to the stock, a downtrend or sell-off may develop that the short-term trader may look to capitalize on by taking a short position in a related stock or index.
2) Time horizon (short to medium term)
While investors are usually in it for the long haul, stock traders generally focus on short to medium term trades. Approaches often used in stock trading include scalping and day trading, which can allow traders to aim for faster results as they can enter and exit multiple trades on the same day.
Discover what kind of trader you are with the DailyFX DNA FX quiz.
3) Initial capital outlays
Stock traders are only required to fund a portion of the cost of their trades in accordance with the margin requirement. For example, if a share costs $10 and the trader wants to trade 100 shares, he will only need $500 to open the trade when the margin requirement is 50%. It must be mentioned that traders should always ensure that the trading account is sufficiently funded to account for unfavourable price movements after initiating the trade, and always make use of a stop loss.
Investors, on the other hand, will often forego the usage of margin or leverage as the interest payment on the borrowed capital may eat into long-term returns of holding a stock.
4) Analysis (Technical or fundamental)
Traders tend to be either technical or fundamental or a combination of the two, meaning there is no definitive answer of which is best in the technical vs fundamental debate.
Popular tools used by technical stock traders include:
Stock traders may use fundamental data to form opinions on the attractiveness of a stock to trade (short or long). If the company has solid fundamentals, the trader may look to go long in the stock and if it has poor fundamentals, traders may look to short the stock.
Fundamental factors of interest to stock traders:
In general, stock traders may face the higher relative levels of risk due to the greater usage of leverage. While leverage can help to produce larger returns, that can also work against the trader in producing larger losses, as well. The use of leverage can more quickly wipe out an account and leave a trader owing more than the initial amount deposited. It is always encouraged to use stops in the effort of limiting losses.
|Potential for sizeable gains over short period of time||Potential for large losses in a very short period of time as leverage magnifies both gains and losses|
|Frequent trading opportunities||Fast paced nature of trading style can lead to rushed, sub-optimal entries|
|Multi-directional opportunities (long and short)|
|Lower initial capital needed compared to owning the stock outright|
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What does stock investing involve?
Below is an overview of how stock investing differs from stock trading, using the same key elements:
2) Time horizon
1) Objective (Capitalize on long term price movement and dividends)
Stock market investors seek to benefit from longer-term price movements and dividend payments. Instead of relying heavily on technicals for ideal entry levels, investors will often focus more on buying shares at attractive (discount) price levels to hold for the long term – riding out recessions and market crashes. Stock investments can be active (frequent buying and selling) or passive i.e. index tracker funds.
Investors usually spend a lot of time researching stocks before investing, looking for strong balance sheets and solid growth potential. The selection criteria however, can vary drastically based on an investor’s risk appetite, whether he/she is buying a single share or adding to a multi-share portfolio.
2) Time horizon (Long term)
Unlike stock traders’ short-term goals, investors focus on the long term – usually aiming for five years or more. Anyone looking at a major stock index will see that over time, markets generally have trended higher. There may be slight declines or major recessions, but recent history suggests that long term trends have been higher. This can help to make stocks as a potentially attractive venue for a long-term inflation hedge. When companies are faced with higher input costs, they usually pass this cost onto the consumer in the form of higher prices of the final good/service. Higher prices can bring higher revenue figures, which will often reflect in a higher share price.
3) Initial capital required (full value of investment)
Long-term investors may forego the usage of margin or leverage as the interest paid on the funds borrowed may eat into long-term results. In this case, with no leverage being employed, investors simply have to pay what the share costs, i.e. 100 shares at $10 per share, or $1000 before taking into account commissions and spread.
4) Analysis (Almost exclusively fundamental)
Stock investors are usually heavily relying on fundamentals in their analysis. Investors scrutinize company financial statements, looking at cash flow from operations, operating expenses, revenue growth, debt, capital investments and any other factors revealing how that company is performing. Additionally, investors will assess how dominant the company/stock is in its stock sector and perform a competitor analysis. It usually makes sense to invest in dominant companies in their respective industry, or in small companies with high growth rates in an expanding industry.
When investing there is always a risk that a stock performs poorly but without the use of margin, investor losses are usually capped at the initial investment plus any dividends that may have accrued.
Management decisions, ever-changing markets and technological innovation can prove to be obstacles or present opportunities to grow and investors have little to no control over this. Investors will usually look at diversifying their stock portfolios instead of simply holding one or two stocks to better insulate from drastic drops in individual share prices.
|Given enough time, a well-diversified stock may benefit from broad-based market trends||Growth can be slow or even negative.|
|Can be less time consuming. Investors do not need to be at their computers all day long managing trading positions||Research and due diligence can be extremely time consuming before making a purchase|
|Choice of buying individual stocks or having a professional manage a portfolio|
|Dividends and preference shares may provide additional benefits over and above share price appreciation|
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Trading vs investing: Which is better?
In the trading vs investing debate there is no empirical evidence to suggest that either approach is superior to the other. In a sense, this realization is reassuring as each individual can gravitate towards the approach they feel best addresses their individual goals and objectives. Become aware of your personality and ensure it complements the way you approach financial markets, whether that’s with a short-term trading or a long-term investing approach.
If you are still unsure whether stock trading or investing is better for you, take a look at our day in the life of a trader series that delves into the daily routines of some of our top DailyFX analysts.