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Oftentimes, the terms investing and trading are used interchangeably when talking about the stock market. While both describe how a person can participate in the buying and selling of securities, there are some distinct differences between investing and trading.
Each one can be thought of as its own unique style with specific pros and cons.
Generally speaking, the main differences between stock market investing vs trading are the strategy for generating profits and how long securities are held. Investors typically aim to hold assets for the long-term while traders look for every opportunity to capitalize on short-term profits.
In this post, we'll explore the differences between these two methods of buying securities. Additionally, we'll also explain why we think that long-term investing is the better path to take and share some tips for how a person can use this method to reduce their risk of financial loss.
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7 Differences Between Stock Market Investing VS Trading
When describing someone who is either an investor or trader, there are several areas of their approach that will oppose. Here are seven ways that traders and investors are different.
Timing refers to how long a person plans to own a security. Investors aim to create wealth through holding their assets for the long-term (sometimes referred to as a buy and hold strategy). This can typically last for years or sometimes even decades.
By contrast, traders will sell their securities as soon as a profitable opportunity arises. This may be weeks, days, or even hours after buying them. For that reason, you’ll sometimes hear these people referred to as “day traders” because of the multiple transactions they’ll make while the market is open for business.
2. Rewards Potential
Investing for the long term can certainly be a profitable venture. The S&P 500 stock market index has produced an average yield of around 10 percent per year when assets are held for a decade or more.
By contrast, traders are hoping to find greater yields and achieve them in much shorter periods. One example of this is when the company GameStop (ticker: GME) made headlines in January 2021. Traders who bought the stock for less than $20 per share and then sold it a month later after it peaked at $325 per share made a small fortune.
Because no one can see into the future, a trader’s strategy can be considered speculative. They’ll use charts and analytics to try to spot trends and potential buying or selling opportunities. But if something happens in the news that’s outside of the fundamentals of the company, then this can throw off their whole strategy and cause them to lose money.
Investors, on the other hand, minimize their risk by avoiding short-term trades altogether. Since we already know that the broad stock market generally rises over periods of 10 years or more, all an investor has to do is simply wait it out. This helps to insulate them from the day-to-day price fluctuations and produce steadier returns.
4. Asset Types
In terms of the stock market, an investor will usually stick to risk-averse financial products such as large-cap stocks, mutual funds, and ETFs (exchange-traded funds). Large-cap stocks are the shares of multi-billion dollar companies with strong reputations. Mutual funds and ETFs are designed for risk mitigation through their diversification of select choice securities.
By contrast, a trader will usually focus on single stocks that they believe are poised for a dramatic price change. These are often lesser-known companies or even ultra-risky penny stocks. In some advanced strategies, the trader may also use options where profits can also be made if the share price of a company goes down (called shorting a stock).
Even though trading is very speculative, there is still a lot of knowledge and experience that’s required to do it successfully. Traders have to understand how to read charts, spot buying and selling opportunities, and then repeat this process several times over. They also have to know the rules involved with more complex strategies such as the use of covered calls.
Conversely, investing requires very little skill to be successful. A person with virtually no investment experience whatsoever can buy a stock market index fund, hold on to it for the next 20 to 30 years, and capture the entire average return of the broad market. This is why index fund investing is regularly recommended to beginners.
Fees are always an important consideration when buying any asset. Because a trader will make far more transactions than an investor, they can also expect to incur more fees.
Normally, stockbrokers charge a commission with each trade. Many of the newer trading apps have eliminated trading commissions to be more competitive. However, they still charge fees associated with FINRA (Financial Industry Regulatory Authority) and ADR (American Depositary Receipt), so there are still some costs involved.
When it comes to the way that stock market investments are taxed, the IRS groups them into one of two classes: Short and long-term capital gains.
A short-term capital gain is one where a profit was made on an investment that was held for less than one year. By contrast, a long-term capital gain is when earnings are received from the sale of a security held for longer than one year.
The IRS has a more favorable tax structure for long-term capital gains than it does short-term capital gains. Therefore, traders will typically have to pay more in taxes than long-term investors.
Stock Market Investing For Long Term Gains
While some traders can be successful, an overwhelming majority of them are unfortunately not. Studies have been conducted that show that more than 97 percent of day traders lose money over time, and less than one percent of them are ever actually profitable.
Because we believe that financial freedom is best obtained through the optimization of risk and reward, we recommend that our readers take a long-term approach to their investments. Here are five ways to do this successfully.
1. Invest With A Long-Term Mindset
Investing is something that a person should see as a lifelong process to obtaining wealth. While the returns may not always be large or even positive some years, it’s been demonstrated the trendline throughout history has been upward. Therefore, those investors who are patient and don’t get greedy for short-term returns will most likely be rewarded.
2. Stick To Your Plan
Once an investor is committed to a long-term strategy, they’ll want to stay true to it and not let the day-to-day fluctuations get in their way.
For instance, when the markets crashed in 2020 at the start of the COVID pandemic, many investors saw their portfolios decline by nearly one-third. However, after about six months, those who didn’t panic and held on to their assets were able to recover about six months later.
3. Don't Try To Time The Market
No matter how much experience a person has in the stock market, they should never fool themselves into thinking that they know what it will do next. Investors don’t presume what the market will do tomorrow. Instead, they know the market will go up over a long period of time, and so they invest accordingly.
4. Use Tax-Advantaged Retirement Plans
One clever way to minimize taxes and fees is for an investor to utilize tax-advantaged retirement plans as much as possible. These would be accounts such as an IRA or 401k.
The main draw to these plans is that contributions and growth are tax-deferred. Investors can save thousands of dollars in taxes on the money they save into account and avoid paying taxes on their earnings until several decades later when they retire.
Additionally, retirement plans help deter investors from making too many short-term actions by imposing penalties for withdrawals made before the age of 59-1/2. This helps promote a good, long-term mindset and investment strategy.
5. Pick Securities With The Best Long-Term Potential
Every investor’s portfolio is only as good as the securities that are inside of it. Whether they wish to use mutual funds and ETFs, or take a more direct approach with investing in specific stocks, these choices should be made so that they’re in alignment with the goals and needs of the investor.
If you’re unsure about how to pick the right investments for your portfolio, then consider getting expert guidance through the Market Insiders program. Market Insiders is a coaching session where members can join a weekly group call and speak to real industry experts. These calls will not only help them to be more strategic in their decision-making process but also help them to practice developing the right skill set for picking their own investments.
Are You An Investor Or Trader?
People looking to capitalize on the financial markets need to be aware of the differences between being an investor and a trader. Investors will take a long-term approach to buying and holding assets for slow and steady growth. Conversely, a trader will make frequent, speculative transactions hoping to profit from the short-term price fluctuations of select securities.
While timing and reward potential are key drivers in each of these strategies, it should also be known that risk plays a huge factor. A person will need to have the right skills and be willing to work with exotic financial products that most common investors aren't comfortable using. In addition, a trader will most likely incur higher fees and taxes than an investor will.
Since financial freedom can be more easily obtained through taking a long-term approach, we'd suggest that you consider the advantages of investing. Not only is there less risk and significant rewards awaiting you in the future, but it’s also an approach that can be combined with the tax-advantaged retirement plans for the ultimate in long-term wealth creation.