The Differences In Investing And Trading

There’s a question that is generally asked by people who are new to financial markets and is debated by experienced ones. What is the difference between trading and investing? The two are very similar.

In my book, The Essentials of Trading, I point out that the only difference is definition. They are both very simple ways to gain capital. When buying a stock, one expects to either earn dividends, or increase in price. Trading has one main difference, being that one expects to exit. This might be in the form of price targeting or in terms of length of time the position will be held. The trade seems to always have a finite life. Investing leaves for open endings. An investor buys a company’s stock with no predefined notion of selling.

For the sake of demonstration, here is an example. Warren Buffet is an investor. He buys a company that is undervalued, and holds on to his positions until he stops liking their prospects. He doesn’t think in terms of a price to exit the stock. George Soros is a trader. He thought the British Pound was overvalued and ready to be withdrawn from the European Exchange Rate Mechanism. His position was based solely on circumstance. Soros exited with a good profit when the Pound was devalued in market. Because an exist strategy was in place, this would qualify as a trade.

Trading can also be defined as another way. It has to deal with how capital is expected to produce a return. The appreciation of capital is the objective in trading. You buy a stock at 10 and expect it to go to 15, expecting it to go through a capital gain. If dividends or interest are paid out along the way, that is fine, but likely only a minor contribution to the expected profits.

Investing, however, looks more toward income over time. The major focal point is income production. So, do investors experience capital appreciation? Unlike in trading, that is not the main motivation, but yes.

Consider what people think of as their biggest investment, being their home. A home doesn’t produce income, though, so is it really an investment? It definitely produces more expenses, with electricity, upkeep, and mortgage. A home is a trade. We buy it and hope it’s value will appreciate. People generally move in for a few years, then sell, which makes it more like a trade. If, of course, you own rental property, it is more of an investment. As mentioned earlier, trading and investing seem very similar. Selling and buying are pretty much the same when it comes to mechanics. Sometimes the analysis that a person does to make decisions is the same as well. Investing and trading are merely different because of definition.

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