Investing vs. Trading – What’s The Difference

There is a question that is sometimes posed by newcomers to the financial markets and even discussed by seasoned players. The issue is how to tell the difference between trading and investing. Because trading and investing are done in very similar ways when seen through the lens of the financial markets, they are often regarded as interchangeable activities.

In my book, The Essentials of Trading, I expanded on this basic concept by proposing that what distinguishes the two is scope specification. After all, both trading and investing are, at their most basic, the use of money in the search of gains. If I purchase XYZ stock, I anticipate the price will rise or I will get dividends, or both. What distinguishes trading from investing, however, is that with trading, one usually has an exit expectation. This may be in the form of a price objective or the length of time the position will be maintained. In any case, the transaction is thought to have a limited lifespan. Investing, on the other hand, has a wider range of possibilities. An investor will purchase a company’s shares having no idea when, if ever, he or she would sell it.

We may use examples to illustrate the distinction. Warren Buffet is a businessman and philanthropist. He buys businesses that he believes are cheap and holds them for as long as he believes in their potential. He does not consider the price at which he will sell the shares. George Soros is a trader (or was while he was still actively operating his hedge fund). His most famous transaction was shorting the British Pound when he believed it was overvalued and about to be removed from the European Exchange Rate Mechanism. He adopted the position he did because of a particular situation. Soros profited handsomely when the Pound was allowed to float freely and rapidly depreciated in the market. That satisfies the requirement of having a predetermined exit, making it a trade rather than an investment.

However, there is another method to describe trading as opposed to investing. It has to do with how the applied money is anticipated to generate a return. The goal of trading is to increase one’s capital. You purchase XZY stock at 10 with the expectation that it would rise to 15 and generate a financial gain. If dividends or interest are given out along the way, that is great, but it is probable that they will only make a small contribution to the anticipated earnings.

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Investing, on the other hand, is more concerned with long-term income. As a result, revenue generation, such as dividends and bond interest payments, becomes the primary focus. Do investors benefit from capital appreciation? True, however, unlike in trading, this is not the primary reason.

Keeping these criteria in mind, examine what many individuals perceive to be their single largest investment: their house. However, according to our second definition of investing, a house is usually not an investment since it does not provide any income in most instances. In reality, it generates significant costs in the form of mortgage interest payments, energy bills, and maintenance. A house is, if anything, a transaction. We purchase it in the expectation that its value would increase over time, increasing our equity. And the fact that many individuals plan to relocate in a few years and sell makes it even less of an investment and more of a transaction. (Of course, owning rental property may be considered investment, unless one is flipping it, which is more trading.)

As previously said, for many individuals, trading and investing seem to be the same thing. The mechanics of purchasing and selling are almost identical. Sometimes the analysis used to make such choices is the same. However, the purpose and description of objectives are what distinguishes trading from investing.

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