I have seen far too many people get swindled with get rich quick schemes promising massive profits from currency trading, stock trading, and cryptocurrency trading. Trading is often pitched as a way to get rich quick by following a few buy and sell signal. Traders often chase instant riches only to see the few dollars they had saved quickly vanish away into oblivion. Many amateur traders do not understand the inherent risks that come along with trading any asset class. A lot of people often confuse trading with investing. They fail to understand the difference between investing and trading. This post will take a look at investing vs. trading.
What is Trading?
Trading involves the purchase of an asset with the intent to sell the asset within a short time period. The time period could be a few seconds, a few minutes, a few hours, a few days, a few weeks, or a few months. Traders enter and exit positions rapidly with the expectation of a short-term gain. Trades are often based on momentum causing events such as recent news, short positions, and purchase activity. Traders often rely on technical analysis which charts patterns by looking at trends to make predictions.
A good example of trading is the recent volatility in the shares of Gamestop (GME). Shares have whipsawed over the past week going from $10 to $400 based on options trading. Option traders destroyed the position of short sellers causing the shares to skyrocket. Retail investors who bought the shares near the low point have benefited tremendously while hedge funds and late traders have lost a fortune.
I am not a fan of trading for the average person because of the following reasons:
- Trading is incredibly risky because it is highly speculative and based on momentum. You can easily lose your entire net worth in one bad trade.
- Most traders lose money. Currency traders who buy and sell currency daily in the Forex market lose money. Cryptocurrency traders who buy and sell Bitcoin daily lose money. Day traders who buy and sell stocks on a daily basis lose money. Over 90 percent of traders lose money. Studies have shown that between 95 to 98 percent of traders walk away with a net loss.
- It is too difficult to consistently predict price movements in markets over the short-term. You cannot faithfully rely on green buy signals and red sell signals.
- Trading requires having an excess of cash. The traders that win have deep cash reserves and are able to have the patience and resources to wait out their position.
- Trading is no way to make a living.
I personally only trade money that I can afford to lose. I treat trading money as if were casino money. It’s my play money that I can afford to lose. It is not my main portfolio. I only trade 1% of my total net worth.
Trading is gambling. It’s not investing.
What is Investing?
Investing entails purchasing an asset with the expectation of generating a profit over the long term. While traders have a short-term focus; investors have a long-term horizon. Investors seek future price appreciation while traders look for price appreciation now. Investors have to be patient and are willing to wait years for an asset to reach its true value. Investors take a buy and hold approach. It is not the asset that determines whether a purchase is an investment or a trade. It is the holding period of the purchase and the underlying motivation for the purchase.
Investors often rely on fundamental analysis when making a purchase. Fundamental analysis involves looking at financial statements, financial ratios, management teams, competition, growth potential, etc. Investors try to find the intrinsic value of an asset and hold it until it reaches that price. Investors do not worry about market timing because they can adopt a buy and hold strategy. While traders look to make fast money; investors look to make money over time.
I am an advocate for long-term investing because:
- Investors have the advantage of using time to ride out short-term losses.
- It is easier to achieve a positive return in any market over the long-term than on a short-term basis.
- Investors are able to receive dividends, stock splits, and earn interest on investments.
- Investing produces lower tax rates. Capital gains tax rates for investors are capped at a maximum of 15% which trades are taxed at the ordinary income tax rate of the trader.
As you can see there are key differences between investing vs. trading. Investing is more of a long-term wealth building proposition whereby trading is a short-term profit seeking endeavor. I believe that long term investing is the safest, most effective, wealth building strategy for the majority of investors.
