Trading vs Investing guide

When it comes to deciding how to invest your money in the financial markets to make it grow, there are two popular approaches: investing and trading. While both methods involve investing money with the goal of generating profits, they differ in terms of investment horizon, risk appetite, financial objectives, and overall strategy.

As it is essential to put your money to work to build your financial freedom, we will review in this article the key characteristics, advantages, and limitations of both investing and trading approaches. This will help you determine which method aligns better with your preferences and goals.

What is investing?

Investing refers to the process of purchasing and selling securities such as stocks, bonds, ETFs, mutual funds, or alternative assets like currencies, commodities, and cryptocurrencies.

The primary objective of investing is to generate profit with a relatively low level of risk by holding a diversified portfolio for an extended period of time. This income can come from the appreciation of asset values over time or regular dividends or interest payments, depending on the chosen financial products or assets.

The buy-and-hold strategy is commonly used in investing, aiming to gradually accumulate wealth over time regardless of short-term market fluctuations, as it is believed that the value of assets will appreciate and generate favorable returns.

Investing is characterized by a long-term perspective, where investors remain resilient during market downturns, anticipating that prices will eventually recover and any losses will be recouped.

Pros of investing

It’s ideal for passive strategies through income generation options (dividends, interest, rental income…).
As you’re planning on holding your investments over time, it will allow you to profit from compounding returns, potentially leading to increased gains throughout your investment time.
Investing usually focuses on quite safe assets following broader market trends, which tend to provide relatively low risk investment options.
Because you’re not actively monitoring your positions or the markets, it is a less stressful approach to the financial markets.
In some countries, it is more advantageous to invest than to trade the financial markets, as the taxes are based on the time you own your financial assets.
Investing may help you stay ahead of inflation.
With investing, it is easier to build a diversified portfolio with several asset classes in order to reduce the risk associated with individual investments.
In the last decade, it has become easier than ever for individuals to start investing through online platforms that offer options to start investing with a relatively small amount of capital.
Because investing doesn’t require you to buy and sell your assets very often, fees should remain low.

Limits and risks of investing

When investing in the financial markets, the concept of opportunity cost refers to both the potential earnings foregone by choosing one asset over another and the capital that becomes tied up and unavailable for other purposes while it is invested.
It might take longer to profit from compound capital than successful short-term traders do.
There is always a possibility of loss, especially if you invest in a company that goes bankrupt (counterparty risk) or if you need your funds at a time when the markets are not performing well.
Investors will have to face specific investment risks, liquidity risk, as well as inflation risks.

Preferred investing styles

We have already discussed the buy-and-hold strategy, but there are various investing styles that cater to different investment preferences, risk tolerances, and objectives.

One type of investor is known as a value investor, who focuses on identifying undervalued assets trading below their intrinsic value to capitalize on potential long-term appreciation as the market recognizes the asset's true value.

Another category is growth investors, who prioritize assets with strong growth potential and above-average growth rates with a focus on capturing significant returns through the appreciation of the investment value over time.

Some investors prefer to emphasize dividend payouts and prioritize investments that provide regular income in the form of dividends to profit from a steady stream of income.

Income investors share similarities with dividend investors as they aim to invest in products that generate a steady income. They often achieve this through fixed-income securities, such as bonds or other interest-bearing instruments.

Preferred investment vehicles and financial assets

Investors usually use various investment options to create a diversified investment portfolio. They will mostly invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, commodities such as Gold, and sometimes alternative investments options such as cryptocurrencies.

3 things to know about investing

You can take advantage of compound interest to invest more capital as time goes by.
As a shareholder, you have the opportunity to receive passive income in the form of dividend payments.
You have to ignore market volatility and short-term bearish movements or crises to focus on long-term perspective, which isn’t always easy in times of market turbulence.

What is trading?

While investing focuses on buying and selling assets over the long term, trading is all about active buying and selling of different financial assets with the goal of making a relatively quick profit from short-term price movements.

Of course, there are different types of trading with various timeframes, ranging from minutes to days or weeks. As the primary objective of trading is to generate quick profit, usually with the help of leverage trading, it is an intrinsically risky activity.

Pros of trading

Trading is the perfect solution for those wanting to be actively involved in the financial market.
As trading is all about capitalizing on short-term and quick price changes, potential quick profits can be made, which helps grow your capital relatively quickly.
There are different trading styles and strategies you can use as an active trader, such as scalping, day trading, swing trading, breakout trading, algorithmic trading, and news trading, among others.
Nowadays, trading is quite flexible and accessible, as there are many online trading platforms to choose from that allow you to access various worldwide financial markets.
As a trader, you can therefore enjoy high liquidity on the most traded financial assets, which means that you can easily enter and exit the market at your required price without affecting the market.
There are many different financial products to use while trading.
With some financial products such as CFD or Contract For Difference, it is possible to profit from bearish movements in addition to bullish movements, allowing you to be able to make money regardless of the market conditions.
With leverage and margin trading, you are able to maximize your market exposure to potentially earn more.
It also allows you to start with just a few hundred euros (or your related currency).
Trading can be used in an hedging strategy to protect existing positions against potential losses.

Limits and risks of trading

As a very short-term trading style, trading can be addictive.
You might be tempted to engage in overtrading, out of boredom for instance.
Active trading requires significant time, focus, attention, and commitment.
Due to the potentially high leverage that can be used for trading, losses can be significant and sometimes higher than your initial deposit.
Some markets can be quite volatile, such as the Forex market, the commodity market or the cryptocurrency market.
Trading can be an emotionally challenging activity, especially during periods of volatility or if you face consecutive losses.
Frequent trading can incur higher transaction costs.
Trading frequently in a specific market or asset class may lead to a lack of diversification in your portfolio.
Traders may encounter technical problems or system outages while executing trades, which can result in missed opportunities or unintended trades.
Successful trading requires a strong understanding of market dynamics and technical analysis. The lack of expertise can limit a trader's ability to make informed decisions.

Preferred trading styles

As traders are looking to profit from short-term price changes, there are 3 main popular trading types: scalping, day trading and swing trading.

While scalping is the most aggressive trading style of all, as scalpers aim to keep their positions open for only a few seconds or minutes, day trading is another popular intra-day trading technique, where traders keep their positions from a few minutes to a few hours.

If traders are not as available to actively monitor and trade the markets, they will turn to swing trading, which is about capitalizing on bigger short-term to medium-term price movements with positions open between a few days to a few weeks.

Preferred trading vehicles and financial assets

Active traders are always looking for liquid markets with a high level of trading activity. Therefore, the most popular markets for short-term trading are the Forex, the indices, and the commodity markets.

3 things to know about trading

Short-term trading is extremely stressful and can be quite addictive.
Most traders lose money when trading, because they do not have any trading plan to follow.
The importance of psychology and emotions is generally underestimated by traders, but greatly influences traders’ decisions.

Final word

Many people wonder what’s more profitable between investing and trading, but there is no one answer, as both investing and trading have their advantages and risks.

Your decision should be based on factors such as financial knowledge, time availability, objectives, risk tolerance, and capital. Some may achieve success and profitability by combining both strategies, while others may prefer one over the other.

The most important aspect to decide which one is best for you is to objectively analyze your personality and trading style to determine the right market approach for you.

It's worth noting that ActivTrades offers both types of accounts, catering to different preferences. A trading account with CFDs enables you to engage in various markets, while a non-leveraged account allows you to invest in over 1,000 popular stocks.

The information provided does not constitute investment research. The material has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and as such is to be considered to be a marketing communication.

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