What Is The Difference Between Investing And Trading?
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There's a question that is generally asked by people who are new to financial markets and is debated by experienced ones. The question being how you differentiate between trading and investing. The two are oftentimes considered interchangeable.
In my book, The Essentials of Trading, I followed this theme by discussing the idea that the difference is merely definition. They are both very simple ways to gain capital. When buying a stock, one expects to either earn dividends, or increase in price. In trading someone expects to exit. This might be in the form of a price target or in terms of how long the position will be held. The trade seems to always have a finite life. Investing leaves for open endings. An investor buys a stock with no intention, or notion of selling.
To demonstrate the difference, here is an example. Warren Buffet is an investor. He buys an undervalued company and holds onto his positions. He doesn't think in terms of a price to exit the stock. George Soros is a trader. He thought the British Pound was overvalued and ready to be withdrawn from the European Exchange Rate Mechanism. His position was based on circumstance. Soros exited with a good profit when the Pound was devalued in market. This meets the criteria for having an exit plan, making it a trade.
There's another way that you can define trading. It has much to do with the manner in which the capital is expected to produce a return. The objective in trading is the appreciation of the capital. If you expect a stock at 10 to go to 15, you expect 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. Dividends and bond interest payments are a major focal point. Can investors experience capital appreciation? Yes, but unlike in trading, that isn't their prime motivation.
Most people think of their biggest investment as their home. Based on our second definition, a home wouldn't be considered an investment, though, as it doesn't produce income. If anything, it produces many expenses. A home is obviously 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. As mentioned earlier, trading and investing seem very similar. Buying and selling are pretty much the same. The decisions are identical as well when it comes to the analysis one does. Definition is what separates trading and investing.
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