Are You an Investor or a Trader? Here are the 5 Differences
Pop quiz: are you an investor, or are you a trader?
While new investors may use the terms interchangeably, the truth is that they’re very different practices, each with their own unique benefits. And if you understand the differences, you’ll be more effective as either!
Here’s a look at some of the differences between investors and traders and how you can choose the right practice for your financial goals.
Investor vs. Trader: The Basics
First, it’s important to understand that while investors and traders both seek financial profit via market participation, investing and trading are two very different things.
Investing is the act of allocating resources with the expectation of generating profit. The goal is to build wealth gradually over a period of time thanks to compounding. Compounding is what happens when you take a number and increase it over and over again by a percentage—such as when an investment generates 10% annual interest. Investors may further grow their capital gains by reinvesting the interest. Either way, investments are typically held for a period of years, and in some cases decades.
If you have a 401(k), IRA, or other retirement account, you’ve invested.
Trading, often called day trading, involves buying and selling assets over short periods—in many cases, minutes, or even seconds. Either way, all sales and purchases (called positions) are closed within the same day of trading. The goal is to generate small incremental returns that, when added together, outperform gains you would achieve through typical buy-and-hold investing. For instance, an investor might be quite happy with 10% annual gains. A trader might be quite happy with a 10% return each month.
5 Key Differences
As you can see, there are obvious differences between investing vs trading. One that crops up right away is the difference in the intent of buying and selling. A trader might buy a stock intending to sell it at a specific price or sell a stock with the intention of buying it back at a specific price. An investor, on the other hand, might buy a stock with the intent to hold it and gain value, and would sell the stock after a long period for financial gain.
On a broader scale, that translates to five key differences between investing vs trading.
The first difference is the time period.
For an investor, time is measured in years. A short-term investment is any investment that can be easily converted into cash within five years. Most investments are held for even longer—some for decades. Most investors buy a new investment with the intent to ride out the highs and lows in between with the expectation that losses will eventually be recovered. In the meantime, they take advantage of fringe benefits like interest, dividends, or stock splits.
For a trader, on the other hand, time is measured in increments of 24 hours. Some traders sell assets within seconds of buying them. To do this, they rely on technical analysis tools and proactive stop-loss orders. The idea is to eke out a small profit on the asset in the short window the trader holds it, and those small profits add up into larger profits with dedicated effort.
Because of the way investors and traders approach time periods, they also have very different approaches to capital growth.
For an investor, capital growth is the art of patience and compounding. It doesn’t matter if an asset loses value in the short-term—the investor intends to hold it long enough that it will hopefully recover the loss. In the meantime, the investor takes advantage of marginal gains, such as compound interest.
A trader, on the other hand, spends their time surfing the ebbs and flows of stock price movements. If a stock goes higher, they sell. And if a stock loses value, they have a stop-loss order to minimize the impact.
This also means that investing and trading come with different inherent risks. Both involve taking some risk with your money, since returns are never guaranteed.
Of the two, investing is lower risk overall. There are many high-risk investment tactics, but the basic buy-and-hold strategy with conventional investments (stocks, bonds, and cash) is comparatively lower risk than trading. The short turnaround and rapid turnover mean that a trader takes a risk every time they buy and sell, with a much shorter recovery period than an investor.
Those Who Do and Those Who Wait
Basically, the differences between investing and trading can best be understood as the difference between those who do and those who wait.
Traders are those who do—and do a lot. They put money in the market fast and get it out just as fast. By the day’s end, they may have bought and sold assets dozens of times. They don’t wait, they act.
Investors are those who wait. Otherwise, they wouldn’t be able to realize any returns from their strategy, since the asset wouldn’t have time to generate returns.
Art vs. Skill
This one is a bit controversial, but in a sense, the gap between investing vs trading is also arguably the gap between art vs skill.
Basically, traders are highly skilled, highly technical individuals who use their skills to perform well in the short-term, irrespective of overall art. But because investors have to stay in the market for a while, they have to learn the art of the game or else they won’t see good results.
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