Every newbie that decides to explore the fascinating and complex world of finance, and eventually decides to chase profits, begins with understanding the difference between investing and trading. They both have the same end goal- which is to make money and what separates them is the way they choose how to go about it. So now that you have made up your mind to gain from this business, the following post will help you figure out which path to take- whether to be an investor or a trader?
1. Basic Strategy:
The difference at the core is the basic belief a trader and an investor has, which he uses to make money from the market. The investor believes in having a strategic approach, while a trader prefers a more tactical way to approach wealth generation.
By strategic approach, we mean that an investor aims to build profits by the adage that money grows money, which is nothing but Long term capital appreciation.
For trading on the other hand, the strategy for profit is about taking advantage of the stock market dynamics to obtain profit from capital risk. The process involves performing fundamental as well as technical analysis to attempt to predict movements of stock price.
Traders categorized on the basis of technique are:
- Fundamental Trader: The trader determines the time and type of security to buy or sell on the basis of company-specific events, also called fundamental analysis.
- Market Timer: This type of trading involves attempting to predict where the market will move next, and bet on that movement to profit from securities.
- Arbitrage Trader: These traders attempt to take advantage of market inefficiencies such as pricing differences of similar instruments in different markets, in order to make profits.
- High-Frequency Trader: A form of computerized trading, the technique involves taking advantage of the difference between bid/ask prices. The profit is small, but since it is code-based, it is in the order of milliseconds and high in frequency.
2. The vehicle of choice:
The one instrument that both investors and traders deal in are equities. The investor will put his own capital to use in buying stocks depending upon the fundamentals of the company. Since the strategy is to buy and hold, the investor bets on the growth of the company whose stocks he is going to buy. On the other hand, for a trader, trading on stock implies holding them for a short period of time, where time depends on market movements. The trader aims to buy the stock when it is low, in order to sell it when it is high, thus obtaining a profit.
Some other financial products that investors generally invest in are Bonds- which serve as important tools against volatility thus helping balance the overall portfolio, Mutual Funds, ETFs, Alternative investment vehicles such as art, wine, venture capital, private equity, real estate, etc.
Traders on the other hand prefer trading in Foreign exchange – involves currency pairs, and attempting to profit from currency movements, Commodities- profits are made by speculation of prices, Derivatives- such as futures, options and forwards which allow traders to bet on the future value of the underlying asset and some even Crypto currency.
3. It’s all about time:
The investment horizon is probably only diffrerence between the process followed by an investor or a trader to make money. Investors typically invest over long term, which could be anywhere between a couple of years to a couple of decades. A trader, on the other hand attempts to make profit from temporary market movements, be it intraday, a few days or months.
Since the investing strategy involves buying and holding, it is done over a long term. An investor will invest in his choice of market security once and generally leave it at that, until such time as he decides he can sell it for profit. A trader, on the other hand profits from his prediction on how the market will move, hence can perform several trades perhaps in just a few seconds. A trader is constantly monitoring the market to find an avenue for profit.
The type of risk that an investor encounters is generally lower, and is restricted to market collapse leading to lowering of value of investment during maturity, or company sell-offs and bankruptcies. They are generally safe from short-term movements in the markets.
For a trader on the other hand, risk comes from exposure to short term volatilities, since prices can jump high or fall rather quickly. Depending on the type of traded instrument, they are also exposed to liquidity risk, currency risk, interest rate risk, counterparty risk, leverage risk as well as transaction risk. Traders are also increasingly becoming more dependent on computer systems exposing them to technical risk.
Since an investor is focused on a long term return through compounding interests and dividends, they typically aim to achieve about 10-20% return on an annual basis. Traders are much more active, take on more risk, and have recurring profits. Their returns vary and can go up to as much as 10% per month.
7. Capital Requirement:
The financial securities that an investor typically invests in requires higher capital investment, than a trader. Traders tend to rely on the use of leverage, hence their capital needs are lower in order to drive profit.
Thus whether you choose to be an investor or a trader essentially boils down to whether you want to make money passively through value of stocks or actively using technical analysis to predict short term moves in the stock market.
So… which one are you?
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