Trading And Investing: Two Sides Of The Same Coin

Jul 26, 2021 06:03 PM ET
Trading And Investing: Two Sides Of The Same Coin

Debates over the years continue over the differences between trading and investing, whether they are the same and which is superior to the other. In truth, no method is inherently better than another in all cases because of the multitude of available traded markets. 

Also, each of these approaches has its unique and varying advantages and disadvantages from instrument to instrument. Ultimately, trading and investing are two sides of the same coin, which is profit. The journeys towards this destination are intriguingly distinct.

Differences between trading and investing

At their core, the main distinctions are time allocation. Trading is about speculating and aggressively capitalizing on short-term movements (in minutes, days, weeks, or months). Investing is a slower, buy and hold approach where the purchase of an asset is held for several years or even longer. 

It's important to note some financial instruments are better suited towards trading than investing or vice versa. For instance, although so-called buy-and-hold investors exist, the technical structure of currencies makes it a preferable option for trading.

The forex markets tend to move in ranges and rarely move in one direction for months or years. If we couple this with leverage, traders can realize a bigger profit with less money down. 

Lastly, buying and holding the real currencies would cost a lot more upfront, and the return would be much less percentage-wise due to having no leverage and transaction costs. In contrast, some instruments like cryptocurrencies are better candidates for both trading and investing.

Compared to fiat currencies, crypto is considered more valuable and deflationary in the current economic landscape. Secondly, the potential for many coins has not been fully realized, meaning a lot more upside is possible in the future. 

Also, cryptocurrencies are more volatile and structurally tend to move in one direction for extended periods on certain occasions. These are some key things when comparing trading and investing; the instrument makes a difference. Let's look at the other contrasts.

Time involvement

The required time when trading and investing are vastly dissimilar. Traders need to conduct frequent execution in their chosen markets and commit at least a few hours to analyze charts and overall monitoring. 

This camp will rely heavily on technical analysis and less on fundamentals. In contrast, a die-hard investor may only perform a handful of transactions in a year and not need to observe their positions consistently. The time involvement only links with the visions between the two camps. 

Investors are more concerned with critical fundamentals, which tend to remain unchanged compared to the ever-changing technical elements. However, ignoring these factors can cause losses in the interim that a typical trader would not have overlooked.

Traders seek to get in and out of a plethora of markets by realizing the highest possible amount of profit. With investing, most analysts agree this endeavor is for building wealth for the long haul. 

Even if someone's investment has already matured into some decent profit, they are unlikely to liquidate their entire holdings because they have a long-term horizon. At the very least, investors could sell off a small portion of an investment with some gains already, but they will often keep holding. 

When traders are faced with the same scenario, their philosophy will incline them to sell as quickly as possible. 

Capital requirements

One of the main attractions for trading most markets nowadays is leverage, a mechanism that has dramatically lowered the barrier to entry in terms of capital requirements. Let's consider the differences between trading a gold CFD and owning the physical gold outright.

In the former, most brokers can easily offer 1:500 leverage or sometimes higher. On the other hand, an investor looking to purchase real metal will probably need to put down a lot more money. 

If the price of gold rose 1%, traders have the advantage of deep liquidity, allowing for a second-quick realization of profits. Investors in this market face a bigger challenge. If they intended to sell, it would be more difficult, take longer, and incur additional costs.

The issue of leverage, as expected, is two-fold as the downside can easily be magnified. Because traders are inclined not to hold their positions for long, their threshold to losses is also shorter. Essentially, traders will tend to close out losing trades sooner.

In contrast, an investor could theoretically hold their gold even if it lost substantially in value. Whether it took months or years to recover, they still have the potential to profit. This attribute is not afforded to most traders due to, again, their inherent vision.

These discrepancies of capital allocation and threshold to losses are present in virtually all securities, further separating the behaviors between the two groups.

Can you trade and invest at the same time?

Fortunately, it's possible to do both trading and investing simultaneously and equally successfully with the extensive selection of available markets. For example, a forex trader could use a swing trading strategy and form a long-term portfolio of cryptocurrency holdings through simple buy and hold.

Their time involvement in this scenario would remain relatively the same. The main challenge is recognizing the mindset required for both practices will vary, and it would be important for the person to distinguish between the two at all times.

Final word

Interestingly, Wikipedia's definition of investing is 'to allocate money with the hopes of a positive return in the future.' Of course, this is a loose definition, and people's description of 'future' will differ substantially, and this is one of the fundamental differences between true trading and investing.

Before venturing into a new market, one should consider all the advantages and disadvantages of that instrument. Based on their circumstances, skills, experience, and net worth, they will observe and determine whether it's more suitable to trade or invest.

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