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Trading vs stock investing: Understand the difference to avoid pitfalls

Updated : November 25, 2019 08:53 PM IST

Traders take the help of technical analysis to estimate the right time to sell or buy a scrip.

While there is no guaranteed formula for making money in the stock market, an investment approach will ensure your success to a large extent.

Trading and stock investing are two approaches by which a person can make money in the stock market. However, more often than not they are used interchangeably. Stock market entrants not knowing the clear differences between the two apply trading strategies and lose money as a result. In reality, these approaches differ greatly with respect to attitudes, risks involved as well as time horizons. Let’s see how they inherently differ and which approach is better suited to retail investors.

Difference based on approach

The first difference is in the approach both these methods employ to make money from the stock market. Traders take the help of technical analysis to estimate the right time to sell or buy a scrip. Traders are not worried about what the business model or future growth prospects of a company is. They base their decisions on hearsay, media reports or by analysing charts and graphs to find the right entry and exit points. Investing on the other hand, takes a long-term approach. Investors look to be a part of a business, which is backed by strong corporate governance and constant innovation and clear competitive advantage. Investing is done with a long term perspective in mind, so investors buy scrips of fundamentally strong businesses and then allow the value of their stock to appreciate as the business grows, ergo, they don’t sell their stocks due to short term market volatility.

It is safe to say, trading is a skill while investing is an art. Both require time, effort and experience in the stock market, however, for different reasons. A trader needs to be thorough with stock market jargon, ratios, market volume graphs, etc. on which he bases his buy and sell decisions, which ultimately have a bearing on the profits he books. Stock investors, on the other hand, leverage their experience to spot winners early on based on their fundamental soundness. Many successful stock investors like Rakesh Jhunjhunwala placed their trust in the potential of a company, and their stocks went on to become multi-baggers.

Difference based on time horizon

Let’s understand by an example. Suppose you have money and you purchase a property in an upscale locality. After a few months, the price of your property appreciates and you sell it booking profits. What you just did can be best described as trading. However, you bought the property because you knew that a national highway will be built close to it in a few years and hence the property price will increase substantially; then you basically invested in the property. You based your bets in the growth potential and held on to your investment keeping a long term perspective.

So trading is done with a short term outlook. Market fluctuations hold a high importance for traders and hence the period of consideration can be seconds, minutes, days or months. In fact, timing makes all the difference to the profits a trader will book. On the other hand, since investors base their trust on the potential of a business which will take anywhere between 5 to 10 years to start showing results, investors invest with a long term perspective ranging between years and decades to even more.

Difference based on risk profile

Both trading and investing involve risk to your capital as they are influenced by market movements. However, trading is way riskier than investing. The reason being trading involves swift decision making to book short-term gains. A wrong entry or exit can have a huge impact on the profits a trader books and he has to be constantly vigilant. Since traders base their decision on external influence and don’t focus on the growth prospects of a business, they are susceptible to making huge losses. In fact, majority of retail investors who went trading in the market and bought stocks based on recommendations of friends or media reports or by copying the portfolio of a successful investor, reported losses. Needless to say trading can oscillate between highs and lows quite rapidly. On the other hand investing as a habit takes time to develop and reaps results in long term. The risks are lower and comparatively the returns are lower when the period of holding is less. However, if stocks are held for a long time, you investment can fetch higher returns due to compounding effect of interest and dividends.

Difference based on attitudes

The final difference lies between the personality or wealth creation attitude of an investor and a trader. Due to the nature of trading, a trader needs to be someone who is constantly alert, takes tough calls quickly and is always on his toes. On the other hand, an investor is slow and steady in his approach, the tendency is to take time to analyse a company thoroughly, buy stocks he believes in and then hold them for a long period.

A trader has high risk tolerance, there will be good trades and bad trades but he is ready to take the risks for short term gains. Investors, on the other hand, are of a moderate risk profile and remain invested for the long haul.

When it comes to stock selection strategy, a trader is skilled at assessing the viability of a stock based on market trends and technical analysis. He does not pay attention to what the company does and only focusses on the scrip price and trade volume. On the other hand, stock selection strategy of an investor is based on how strong a business is.

Which is better suited for a retail investor?

If you look at the differences carefully you will be able to see that investing is more suited to retail investors who want extra exposure to equities. The advantages that accompany a stock investing mindset are numerous. All you have to do is have faith in a business that is strong in its core offerings, is constantly innovating and adapting to customer requirements and has a solid management team backing it. Once you are thoroughly convinced of your choice, you just need to hold on to your investments allowing them sufficient time to reap results. While there is no guaranteed formula for making money in the stock market, an investment approach will ensure your success to a large extent. It will also allow you the much-needed peace of mind that traders never get in there attempts to time the market. So analyse a company fundamentally, invest in the business, remain unperturbed by the market noise and stay invested to reap long term benefits.

Harsh Jain is COO and Co-Founder of Groww.

Trading vs stock investing: Understand the difference to avoid pitfalls

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