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Investing vs Trading: Differences, Similarities, Types, Pros & Cons
Trading and investing are two distinct spheres within the realm of managing and growing your money, assets and wealth. A trader often has different goals and aspirations compared to an investor, and has an alternative market perspective.
QUOTE
I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading. I don’t think any one book will do it for you.
Big ideas
- The clearest distinction between trading and investing is the time horizon; positions are entered and exited from much more quickly when trading than when investing.
- Both trading and investing are broad terms, and there are many varieties of both traders and investors.
- Investors are generally more concerned with fundamental analysis, while traders are more concerned with technical analysis (moving averages, stochastic indicators, etc).
What is trading?
Traders look for quicker profits and higher rewards as compared to investors. Returns are sought on an hourly, daily, weekly, and/or monthly basis. For High-Frequency Trading (HFT), returns are even sought on a per-second basis, and this is done via AI and algorithms, usually being the domain of large institutions and hedge funds.
The most common financial assets for trading
While an investor might seek a 5% - 20% annual return, traders can look for a 10% return each month, while fully anticipating the prospect of a 10% or larger loss over the same period.
That said, each trader/investor will have their own distinct targets and timeframes. The increased return also means that traders take on more risk, with more and more frequent losing trades. They need to use stop losses to protect positions and be very vigilant in monitoring the market.
Trading takes much more focus and discipline, generally speaking, than investing. Traders cannot afford to let time work its magic and need to make more decisions in a shorter time frame to maintain profits. Fees and other criteria such as execution speed and market liquidity also need to be factored into trading strategies to maintain profitability.
That said, each trader/investor will have their own distinct targets and timeframes. The increased return also means that traders take on more risk, with more and more frequent losing trades. They need to use stop losses to protect positions and be very vigilant in monitoring the market.
Trading takes much more focus and discipline, generally speaking, than investing. Traders cannot afford to let time work its magic and need to make more decisions in a shorter time frame to maintain profits. Fees and other criteria such as execution speed and market liquidity also need to be factored into trading strategies to maintain profitability.
The different types of traders
Traders are usually defined by their holding periods, the amount of time before a position is bought or sold.
- Position trader - positions are held from months up to one year
- Swing trader - positions are held from weeks to months
- Day trader - positions are held up to one trading day
- Scalping - positions are held from seconds to minutes
- High-Frequency Trading (HFT) - positions are held for seconds or less than one second
For day trading, scalping, and HFT, sophisticated software is often deployed. It’s very important for traders to use risk mitigation procedures and to be very aware of capital management. Even small delays in trade execution can be extremely costly for intraday traders.
Traders that use leverage can also be at further risk, especially when dealing with derivative products such as futures, forwards, and options. Traders can further be categorised by product type, such as a commodities trader or an FX trader. Or with a hybrid approach, such as an FX day trader or an equity position trader.
Traders that use leverage can also be at further risk, especially when dealing with derivative products such as futures, forwards, and options. Traders can further be categorised by product type, such as a commodities trader or an FX trader. Or with a hybrid approach, such as an FX day trader or an equity position trader.
What is investing?
Investors look for yearly returns as opposed to daily, weekly, or monthly rewards. So they have a longer time horizon compared to traders. Consider an investor who allocated 5% of his portfolio to a 10-year UK government bond (GILT) with a 4% return. Such a long time frame and low rate of return will not interest a trader.
Investors need a diversified portfolio and are concerned with asset allocation. They are comfortable with a lower return and decreased risk. Positions are entered based on fundamental information such as company financial statements (balance sheets, profit and loss, income statement, etc) and macroeconomic data (PMI reports, inflation statistics, federal reserve interest rates, etc).
Of course, there are other investors that can invest in hedge funds, startups, and higher-risk corporate bonds with expectations of 15% annual returns and above. They also seek to maximise returns through tax harvesting, dividend reinvestment, and other mechanisms.
Venture capitalists (VCs) are technically classified as investors. They often look for 50x - 100x returns, though these are very rare and wins are offset by the high failure rate.
Of course, there are other investors that can invest in hedge funds, startups, and higher-risk corporate bonds with expectations of 15% annual returns and above. They also seek to maximise returns through tax harvesting, dividend reinvestment, and other mechanisms.
Venture capitalists (VCs) are technically classified as investors. They often look for 50x - 100x returns, though these are very rare and wins are offset by the high failure rate.
The different types of investors
Unlike traders, investors are not usually classified by their holding periods, though you could loosely divide them into short (1 - 3 years) medium (3 - 10 years) and long-term (10 years +) investors. More commonly, they are classified based on investment style:
- Active investors - these guys give permission to a fund manager to take control of their investment, making changes as necessary to maximise profits. They have higher expense ratios (the annual cost of investing in the fund) to pay for the more active management, requiring increased human activity.
- Passive investors - this group largely uses ETFs and robo-advisors that automatically manage funds on behalf of clients, after taking risk tolerance and age into account. Fees are very low. Historically, passive investments have often outperformed their actively managed equivalents over the long term.
- Growth investors - this style looks at metrics such as earnings growth rates, return on equity, profit margins, and dividend yields. The aim is to identify high-growth companies that are innovators in their field.
- Value investors - aka the "Warren Buffett style" seek to purchase undervalued firms in the hopes that their true value will one day be priced in. This approach has been popularised largely due to the work of Buffett’s mentor Benjamin Graham. Value investors often look for a high dividend yield and a low price-to-earnings ratio, among other metrics.
Investors can also be classified based on the asset class. You can get large-cap, medium-cap, or low-cap equity investors who all invest according to rules surrounding the market capitalisation of stocks. You might also get real estate investors, bond investors, commodity investors, ETF investors etc.
The permutations and criteria are nearly endless; UK short-term real estate investors, eco-focused tech startups in the USA, oil and gas derivatives products in the eurozone markets, etc. Individual investors need to identify their areas of interest and their risk tolerance to narrow down the field.
The permutations and criteria are nearly endless; UK short-term real estate investors, eco-focused tech startups in the USA, oil and gas derivatives products in the eurozone markets, etc. Individual investors need to identify their areas of interest and their risk tolerance to narrow down the field.
Differences between investing and trading
Investing and trading are similar in the sense that both of them are financial methodologies used for the purposes of maximising returns and minimising risk. Both operate within a secure regulatory environment to facilitate safety for all market participants.
Criteria | Investing | Trading |
Time horizon | 1 to 10+ years | Intraday to 12 months |
Leverage | No | Yes |
Risk | Lower | Higher |
Frequency | Lower | Higher |
Active Management | Lower | Higher |
Success (win) rate | Higher | Lower |
Returns | 5% - 20% yearly | 5 - 20% monthly |
Methodology | Company fundamental analysis | Technical price movements |
And there is even something of a grey area for investors/traders with time horizons between 6 months and 2 years, who can be seen as traders or investors. An individual might hold positions for an average of 1 year, but factor in technical indicators along with macroeconomic data, for instance. Hybrid approaches can muddy the waters somewhat.
It’s also possible to have long-term trades alongside short positions, though it is often advised to stick to one area and master it instead of being a jack of all trades.
It’s also possible to have long-term trades alongside short positions, though it is often advised to stick to one area and master it instead of being a jack of all trades.
Similarities between investing and trading
The ultimate similarity is that both traders and investors take financial positions within the financial markets, which put them in line to either win or lose money. Perhaps more significantly, here are some specific criteria that draws a line between the two:
- Risk of loss - trading involves a higher risk of loss due to short-term market fluctuations and frequent transactions. Traders often face quick, significant losses if market movements go against their positions. Investing, in contrast, generally has lower risk as it focuses on long-term growth.
- Tax implications - trading typically results in higher tax liabilities because profits are often classified as short-term capital gains, which are taxed at higher rates. Frequent trading increases the tax burden. Investors, who hold assets longer, benefit from lower tax rates on long-term capital gains.
*Tax rates and rules differ between jurisdictions, so traders and investors should be aware of local tax laws. - Time and effort - trading requires substantial time and effort. Traders must constantly monitor markets, execute timely trades, and analyse trends daily or even hourly. Investing is less time-intensive, as it involves making decisions with a long-term perspective. Investors typically conduct thorough research initially but then hold assets with less frequent adjustments.
- Portfolio - a trader’s portfolio is often more concentrated, with fewer, high-risk positions that change frequently based on market conditions. This approach aims for quick returns. In contrast, an investor’s portfolio is typically diversified across various asset classes, reducing risk and focusing on steady, long-term growth.
Costs and fees of investing and trading: nuances and examples
Understanding the costs and fees associated with trading and investing is essential for anyone looking to maximise their returns. These expenses, though sometimes overlooked, can have a significant impact on overall profitability.
Traders and investors face different types of costs. Traders often deal with commissions and spreads and overnight funding costs, while investors encounter management fees and various fund expenses. These costs might seem minor on the surface but can compound over time and can significantly affect performance.
Traders and investors face different types of costs. Traders often deal with commissions and spreads and overnight funding costs, while investors encounter management fees and various fund expenses. These costs might seem minor on the surface but can compound over time and can significantly affect performance.
Trading costs: Commissions and spreads
For traders, commissions and spreads are the primary costs. Commissions are the fees paid per trade, charged by brokers. These fees can vary widely depending on the broker and the trading platform.
EXAMPLE
If you’re paying a £10 commission per trade and you make 50 trades a month, that’s £500 in commissions alone. Over a year, this adds up to £6,000. This is money directly subtracted from your profits or added to your losses.
Spreads are another critical cost for traders. The spread is the difference between the bid (buying) price and the ask (selling) price of a security. If you buy a stock at £100 with a spread of £2, the stock needs to increase in value to £102 before you can break even.
Spreads are another critical cost for traders. The spread is the difference between the bid (buying) price and the ask (selling) price of a security. If you buy a stock at £100 with a spread of £2, the stock needs to increase in value to £102 before you can break even.
If you’re trading frequently, these spreads can add up, especially in volatile markets where spreads might widen, further increasing costs. In high-frequency trading, even a small spread can significantly impact overall profitability.
Fortunately, Trading 212 minimises the cost of trading by offering zero commissions across a wide range of UK, US and international stocks and ETFs.
*Other fees may apply. See our terms and fees.
Fortunately, Trading 212 minimises the cost of trading by offering zero commissions across a wide range of UK, US and international stocks and ETFs.
*Other fees may apply. See our terms and fees.
Investing costs: Management fees and expenses
Investors, particularly those who invest in mutual funds, ETFs, or index funds, face different types of costs, primarily management fees and expense ratios. Management fees are typically charged as a percentage of the total assets under management.
EXAMPLE
If you invest £50,000 in a mutual fund with a 1.5% annual management fee, you’re paying £750 each year in fees. Over 10 years, this fee could cost you £7,500, excluding any additional fees or compounding losses.
Expense ratios represent the annual expenses of a fund, expressed as a percentage of the fund’s average assets. For instance, a fund with an expense ratio of 0.75% on a £50,000 investment would charge £375 per year.
Expense ratios represent the annual expenses of a fund, expressed as a percentage of the fund’s average assets. For instance, a fund with an expense ratio of 0.75% on a £50,000 investment would charge £375 per year.
While fees may seem small, over the long term, they reduce the overall growth of your investment. If the market returns 7% per year, but you lose 1.5% to fees and expenses, your effective return drops to 5.5%, which can compound to a substantial difference over the decades.
Impact of costs on profitability
The impact of these costs on profitability cannot be overstated. For traders, frequent trading with high commissions can erode profits quickly. Even if you’re making small gains on trades, the cumulative cost of commissions and spreads can significantly reduce your net returns.
EXAMPLE
A trader making £10,000 in profits might lose £3,000 to commissions and spreads, effectively reducing net profits to £7,000.
For investors, the compounding effect of management fees and expenses can be even more pronounced.
Over 30 years, a £100,000 investment with a 7% annual return could grow to around £761,225. However, if you’re paying 2% in fees, your investment might only grow to £432,194. That’s a difference of £329,031, all lost to fees.
For investors, the compounding effect of management fees and expenses can be even more pronounced.
Over 30 years, a £100,000 investment with a 7% annual return could grow to around £761,225. However, if you’re paying 2% in fees, your investment might only grow to £432,194. That’s a difference of £329,031, all lost to fees.
Recap of Investing vs Trading
At a broad level, it can be said that traders operate on much shorter time horizons, are more comfortable with risk, and look for additional profits. Investors, meanwhile, have a multiyear timeframe and are comfortable with lower returns and lower risk.
Investors usually look at fundamental information (macroeconomic data and company financials) while traders pay attention to news and technical price indicators to inform their decisions. Of course, there are many variations and nuances to this broad assessment, with hybrid models and subcategories.
Individuals will need to decide what their personal goals are, how much risk they are willing to take on, and what markets/products interest them most. This will help them to figure out what side of the divide they wish to plant their financial acorns in, and grow from there.
Investors usually look at fundamental information (macroeconomic data and company financials) while traders pay attention to news and technical price indicators to inform their decisions. Of course, there are many variations and nuances to this broad assessment, with hybrid models and subcategories.
Individuals will need to decide what their personal goals are, how much risk they are willing to take on, and what markets/products interest them most. This will help them to figure out what side of the divide they wish to plant their financial acorns in, and grow from there.
FAQ on Investing vs Trading
Q: What is the difference between an investor and a trader?
An investor focuses on long-term gains by holding assets like stocks, bonds, or real estate for extended periods. A trader, on the other hand, seeks short-term profits by frequently buying and selling assets based on market movements. The primary difference lies in the time horizon and approach to risk.
Q: Is trading the same as investing?
No, trading and investing are not the same. Trading involves frequent transactions aiming for quick profits, often within days or weeks. Investing is about potential long-term profits, holding onto assets for years, even decades, to benefit from appreciation, dividends, or interest.
Q: Can an investor be called a trader?
An investor is generally not called a trader because the objectives and strategies differ. While both deal in buying and selling assets, investors focus on long-term growth, whereas traders are more concerned with short-term market fluctuations and quick gains.
Q: Can you be an investor and a trader?
Yes, one can be both an investor and a trader. An individual might invest in some assets for the long term while simultaneously trading other assets for short-term gains. The key difference is how they approach each type of asset and their objectives for each.
Q: What is the investor vs trader mindset?
The investor mindset is patient and focused on long-term value, often ignoring short-term market noise. Investors prioritise stability and growth over time. The trader mindset, however, is more dynamic and opportunistic, constantly seeking to capitalise on short-term market movements, with a higher tolerance for risk and volatility.
- Leverage: The use of borrowed capital to increase potential returns on an investment. While leverage can amplify gains, it also magnifies losses.
- Market Liquidity: The ease with which an asset can be bought or sold without significantly affecting its price.
- Asset Allocation: The process of diversifying investments across different asset classes (such as equities, bonds, and commodities) to balance risk and reward according to an investor’s goals and risk tolerance.
- Fundamental Analysis: A method of evaluating an asset’s intrinsic value by examining economic, financial, and company-specific factors such as earnings, revenue growth, and macroeconomic indicators. More commonly used by investors than traders.
- Technical Analysis: A trading methodology that uses historical price data, chart patterns, and indicators (such as moving averages and stochastic oscillators) to predict future price movements. It is widely used in trading strategies.
- Venture Capitalists (VCs): Investors who provide funding to early-stage or high-growth startups in exchange for equity. VCs seek substantial returns but take on significant risk, as many startups fail. Their investments typically focus on innovation and high-growth potential.
