The two key approaches
Deciding whether to trade or invest in the stock market may seem like the same thing. They both involve buying and selling stocks for a profit, right? Actually, the two key approaches differ significantly from one another. Each approach values different metrics in their decision making but they are best differentiated by their varying investment time horizons. Trading is about taking advantage of short-term shifts in stock prices whilst investing is focused on the long-term growth of a company and its stock price. Trading focuses on the past and present performance, whilst investors focus on the future.
Past, present, and future performance
Trading focuses primarily on technical analysis, a method of identifying patterns in price movements to forecast future price movements. This is done by analysing charts of the past and present price movements to find indicators of when to buy and sell. In addition to this, traders monitor price-sensitive news and engage in speculation based on company-specific or external news which may affect the stock price. This can be combined with fundamental analysis, which we’ll cover below, to gain a better understanding of when to buy and sell. Investing utilises primarily fundamental analysis, which is a method of measuring a stock’s value by analysing economic and financial factors that determine the company’s value. This is done by analysing company financial statements and the competitive landscape of the company’s industry to estimate growth opportunities and a forward-looking stock price for the company. While there are different strategies to investing, and not all involve in-depth fundamental analysis, most involve buying a stock where the forward-looking stock price exceeds the current stock price.
Time in the market or timing the market
Reminiscent of the iconic fable of the hare and the tortoise, investing tends to focus on slow yet consistent returns over a long period of time to achieve your investment goals. As an investor, you shouldn’t expect to become rich overnight, but you are more confident you will develop returns in the long term. On the other hand, like the hare, trading focuses on making returns in an extremely short time horizon, varying from minutes to days to sometimes months. Traders target stocks with high trading volatility and volumes, allowing them to take advantage of price movements and quickly liquidate their positions to make a profit. Investors are less concerned about their portfolio liquidity and volatility since their returns are less subject to the day-to-day pricing of their stocks.
How do I know what’s best for me?
Deciding on whether investing or trading is the best approach for you depends broadly on what your investment goals are, how much time and effort you are willing to commit, how much risk you are willing to take, and what you wish to invest in. While it’s not a binary decision between investing and trading as you can do both, these considerations may indicate which approach is more suitable for you.
What are your investment goals?
Your investment goals will likely change over your life. Depending on your age, employment status, and portfolio value, you will likely change your investment goals and the strategies you use to achieve those goals. Is your goal to make as much money as possible over a short period or is it to slowly grow your money over a longer period? These two extremes are just that, extremes, and varying investment goals exist on a spectrum between the two. Considering your investment goals, both short- and long-term will affect which approach(es) you might take now and which you may take later on in life.
What stage of your life are you in?
In deciding what your investment goals are, one of the most important things to consider is what stage of life you are at. How old are you? Are you planning to retire in the coming decade, or have you just started your career? If you are or planning to retire, your focus in wealth creation will likely be on generating more sustainable and frequent returns (Read Our guide to Investing in Dividend Stocks) from your investments to substitute your lost income. This will usually come from investing in fixed income securities, bonds, or stocks that offer frequent dividends. On the other hand, if you are younger, you may want to take on more risk to increase the value of your portfolio by investing in growth stocks or utilise technical analysis to trade a portion of your portfolio.
How much time and effort are you willing to commit?
The amount of time and effort you can afford to spend, both in the length of holding investments (time horizon) and the time spent analysing and monitoring your investments (effort) will point to which investment options you should consider. While the approaches of investing and trading both have their benefits, the amount of time and effort required between the two varies significantly.
Long investment horizon, low to medium effort
Whether you’re retiring or have just started working, you likely have a few years to invest your money into the stock market. If you’re young, you may want to take on more risk than if you’re older, either way, you can afford to weather the day-to-day price changes and take a longer-term view, even if that’s only a year or two. Within investing, there are various degrees of involvement depending on your security selection. People who invest in assets with broad diversification such as ETFs, LICs, and Mutual Funds tend to only need to check their investments occasionally, focusing on sustained long-term growth through diversification (read diversification: Allocation Size – Don’t Have Lots of Insignificant Positions). For investors with time to spend every week, targeting specific company stocks after researching their performance and position in the market may be more suitable.
Short investment horizon, medium to high effort
While investing is an approach that can be taken throughout your whole life, with varying degrees of involvement, trading demands more effort on a weekly, hourly, and daily level to see returns. Since this process is time-sensitive with a high degree of involvement, you will also need the necessary knowledge, focus, and risk appetite to succeed in this approach. Trading involves frequent transactions relative to investing, so you also need to be conscious of brokerage costs which are charged every time you buy or sell a share. Consequently, to break even on a trade, your position’s growth must at least be equal to the fees of both buying and selling the stock.
How Much Risk Do You Want to Take?
Whilst an investor might make an annual return of 10%, a trader can be able to make that same amount within a couple of hours. Nonetheless, on the flip side, a trader can also lose the same amount in that same period of time. If you’re the type of person who gets more emotionally involved when losing $1 compared to winning $1, you may be risk-averse, in which case trading may not be for you. However, if slowly seeing the value of your portfolio of stocks increase bores you and you want more involvement, trading might be your choice between the two.
High risk, high reward (perhaps)
Although both trading and investing require you to not be emotionally involved to avoid buying or selling too early or too late, trading is a much more volatile approach to being involved in the market. The risk appetite and your risk averseness will play a major role in deciding which approach to take. As a day trader, you may see significant losses in returns one day, only for them to be regained the next day, or never. On the contrary, it can be very exciting and satisfying to see greater gains in a day than what a market index would achieve over a year.
Variable risk, variable reward (probably)
Investing can have very varied risks, depending on your choice of securities. Investing in individual high-growth stocks with high risk can be as risky as trading, but there is a myriad of investment options from low-risk bonds to speculative small-cap stocks. As such, an investor can tailor their investments to their risk appetite and investment goals. That being said, investing is still risky, and there is always a chance of losing money in the market. However, this can be mitigated by appropriate choosing a balanced portfolio according to your personal preferences.
What investments suit each approach best?
So now that you have an idea of which approach you wish to take, finding out what to invest in is the next goal. For trading, since you wish to take advantage of volatility in price movements and liquidity so you can enter and exit a trade quickly, stocks with a certain trading volume and high price movement volatility are best. ETFs, managed funds, or LICs often have less volatility and volumes, as well as require you to understand the underlying assets in the securities, making it harder to trade purely on price movements.
However, investing in ETFs, managed funds, or LICs may be a good option because of their lowered risk and volatility while providing broad diversification to a certain sector, market, or thematic (See our article: ETF Investing – What Different ETFs Are There, How Do They Work). Utilising an ETF, managed fund, or LIC as a core investment and picking stocks to add in addition to this is a known strategy called the Core & Satellite Portfolio Management, useful for lowering risk while picking some stocks for added returns. Alternatively, you can simply pick and choose the stocks you are interested in after doing the necessary due diligence on the company’s performance future outlook.
By now you should be confident in the two approaches of investing and trading. With whichever approach you choose, now or in the future, reading our “How to invest in stocks? Maqro’s Beginners Guide” to gain practical insight into investing in stocks will help you on your trading and investing journey.