The Differences In Investing And Trading
There is one main question asked by those who are new to the financial markets
, and even debated by experienced participants. How do you differentiate 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 the most simple application of capital in the pursuit of profits. If I buy a stock, I expect either to see the price increase, or to earn dividends. In trading, one generally has an exit expectation. This might be in the form of price targeting or in terms of length of time the position will be held. The trade has a finite life. Investing is more open-ended. An investor will buy a company's stock and may never plan to sell.
Here is an example. Warren Buffet can be our investor. When he sees an undervalued company, he buys it, and hold on to his positions for as long as he continues to like them. He will not worry with thinking about a price to exit the stock. Think of George Soros, the trader. His famous trade was shorting the British Pound when he though the currency was overvalued and ready to be withdrawn. His position was based solely on circumstance. When the Pound was allowed to float freely, and devalued in the market, Soros exited with a good profit. This was a trade, rather than an investment, because he had a predefined exit.
Trading can also be defined as another way. It has to deal with how capital is expected to produce a return. In trading, the appreciation of capital is the objective. 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's fine, but only a small contribution to the profits expected.
Investing, however, looks more toward income over time. Income production is the major focal point. So, do investors experience capital appreciation? Sure, but it isn't the main motivation.
Consider what people think of as their biggest investment, being their home. Based on the second definition of investing, however, a home isn't really an investment at all because it doesn't produce income. It definitely produces more expenses, with electricity, upkeep, and mortgage. In fact, a home is a trade. We buy it and hope it's value will appreciate. On top of that, the fact that people plan to move in, then sell it makes it even more of a trade. If, of course, you own rental property, it is more of an investment. Trading and investing are much alike. 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. The intention and definition is what separates trading and investment.
by: Jean Griffin.
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