What Is The Difference Between Investing And Trading?
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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 oftentimes considered interchangeable. In my book, The Essentials of Trading, I point out that the only difference is definition. They are both very simple ways to gain capital. When buying a stock, one expects to either earn dividends, or increase in price. Trading has one main difference, being that one expects to exit. This might be in the form of price targeting or in terms of length of time the position will be held. The trade seems to always have a finite life. Investing leaves for open endings. An investor buys a company's stock with no predefined notion of selling. 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 doesn't think in terms of a price to exit the stock. Think of George Soros, the trader. His famous trade was shorting the British Pound when he thought the currency was overvalued and ready to be withdrawn. His position was based on circumstance. When the Pound was allowed to float freely, and devalued in the market, Soros exited with a good profit. This meets the criteria for having an exit plan, making it a trade. Trading can also be defined as another way. It has to deal with how capital is expected to produce a return. The appreciation of capital is the objective in trading. 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 is fine, but likely only a minor contribution to the expected profits. Looking at income over time is considered investment. Income production is the major focal point. Can investors experience capital appreciation? Sure, but it isn't the main motivation. With this in mind, think about what many people consider their single biggest investment, 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. If anything, it produces many expenses. In fact, a home is a trade. When we buy it, we hope it will increase our equity. The fact that people usually plan to live in it for a few years, then sell it makes it even more of a trade. Owning rental property, of course, can be seen as an investment. Trading and investing are much alike. The semantics of buying and selling are much in the same. The analysis to make the decisions is identical as well. Definition is what separates trading and investing.