Trading Vs Investing. Which is better?
To all the newbies in the stock/share market, the terms investing and trading sound way too similar but are there some key differences between these two methods of wealth creation in the equity markets.
Even some people who know about the differences still get confused on which of the two will yield higher returns.
Let’s talk about TRADING first
Trading is like riding on the momentum of the market.
Trading involves frequent transactions of buying and selling. The transactions could be as long as 2-3 days or 1 day or within few seconds.
Trading requires a little attention for a certain period. Transactions of buying and selling in trading could be of stocks/shares, commodities, currency pairs, and other instruments.
Profit generation in trading is generally due to buying stocks at a lower price than selling those stocks when prices of those stocks have soared high in the market in a very low time.
According to various periods, a trader is classified into the following types:
Position traders: Positions are held from one month to years.
Day Trader: Positions are held throughout for the same day only, no overnight positions
Swing Trader: Positions are held from few days to weeks.
Scalp Trader: Positions are held for more than a few seconds to minutes with no overnight positions.
Investing is the long term strategy of wealth creation. Investment could be done by buying and holding some good portfolio stocks, mutual funds, bonds, and other instruments.
The idea to hold the investment for a long period such as for a certain period of years or even decades makes it one of the best ways to make passive money. It includes advantages such as interest rates, dividends, and stock split over a certain period.
In investment, the daily or weekly market fluctuations even the downtrends do not worry the investor as they have faith that after a certain downtrend is over there would an uptrend and the losses would be recovered.
To have this type of faith in their stocks, an investor highly depends on market fundamentals and price to earnings ratios, and management forecast. A good investor does a complete analysis of let’s say a company if he’s in investing in their stocks.
Let’s understand this by a simple story.
A person called Ram was roaming in the outskirts of a village where he lived. While walking he saw some farmers carrying mango seeds with them. He stopped them and asked about the mango seeds. He came to know that those mango seeds are of a very top variety of mango species and the farmers are selling them at a very low price. He bought the mango seeds for 10 mango seeds for 1$ from the farmers.
In hope that he would sell these 10 mango seeds for 10$ in the city which would give him a profit of 9$ in total. He goes to the city the next day and he sells all the and gains a profit of 9$. He was very happy with this quick income.
The above story is a classic example of trading.
Let’s take another perspective.
This time Ram takes those seeds from the farmers but instead of trading them to another buyer, he sows them into his fields. He looks after them for 3 years until the seed has turned into a full-grown tree, between this 3 years the price of mango seeds had soared high but Ram was confident enough that he has done the right thing of sowing the seeds instead of trading them when the price of seeds in the market was soaring high.
After four years, the mango trees started bearing fruits and it was in a huge amount. Ram had fully grown 10 trees in these 4 years which were full of mangoes.
He plucked the mangoes from the trees and sold them for 10$ for a kilogram.
From each tree, he collected 20 kilograms of mangoes.
which sums to a total of 20×10 = 200 kilogram of mangoes.
He sold them for 10$ per kilogram which sums up to
200 x 10$ = 2000$
In this way, Ram earned way more money than trading but the period was long. Since Ram didn’t have a shortage of money with him he went the investing way to earn money. If Ram had a shortage of money in the current situation maybe he would have gone to the trading way and earned a quick amount of money.
Conclusion – Which is better stock trading or investing?
1) Trading is done for daily or weekly income. It’s an income generation source while Investing is a proper wealth generation source.
2) In investing in something, people do more research than trading. They have their market fundamentals, expert suggestions, market reports to look for.
While in trading, sometimes the trader doesn’t have a proper idea of what a particular company does or how it functions. He is just interested in the fluctuations of the share price of the company so that he could earn a quick profit.
3) Trading involves a high-risk example, Intraday Trading happens within a day you have to do your sellout on that day at whichever price applicable if the time of closing the exchange have few minutes left. But if you can calculate your risk and has and would handle a few ups and downs, you are good to go in trading.
On the other hand investing has lower risk and also the returns are high (in the long run) due to compounding interest and dividends holding for a higher amount of time.
4) You should also consider Transaction cost in trading. Although this, not a big concern still it affects the money you earn. When you consider brokerage, statutory cost, and hidden costs like illiquidity and spread risks the cost of trading is high.
5) How could we forget the Tax impact on trading?
When you do trade you always show it as a business income or you show it as short-term capital gains. Either way, you are taxed at your peak rate which is around 34% after surcharge.
Long-term investing is still more economical than this.
Getting back on what a person should choose between these two options of money-making. It’s you who will decide whether you want to earn profit in a short time goal or you have the patience with clear fundamentals to hold your stocks and sell them at a much higher price in the long run.
In my personal opinion, what I do is I choose a combination of both methods. I have even invested for the long run and when I’m in a week I do day trading or swing trading.
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