What is the Difference Between Trading Stocks and Investing?
What is stock trading? What is investing? The mechanics are similar, but the goals are different.
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Investors love jargon. A lot of the terms are straightforward once you understand them, but different investing philosophies use words in different ways. The way you invest changes the way you talk about investing—how much risk you accept, how many trades you do, how much and what kind of research you do, and so on.
While there are many schools of thought, there are two very broad categories: traders and investors.
Stock Trading Buys and Sells for Profit
Who trades stocks?
Think of a broker on Wall Street, running back and forth in his shirtsleeves, yelling "Buy! Buy! Buy!" one moment and "Sell! Sell! Sell!" another moment. A stock trader buys and sells stocks frequently, when they find a short term advantage.
The phrase short term advantage is very important. The goal of a scalper trader like this is to make money fast. What the underlying company does or sells isn't as important as the belief that the price per share will change soon to the trader's advantage.
If the broker's right, they can make money. Who are they making this money from? Other traders.
Stock Investing Buys Companies Worth Owning
Who invests in stocks?
Think of a little old lady who socked away $10 a week from 1954 until 2014 and ended up with millions of dollars worth of Coca-Cola. Some years she lost money. Some years she gained money. She reliably reinvested her dividends. Over that those sixty years, she turned a little bit of money into a lot of money thanks to patience and compound interest and owning a great stock.
An investor takes a long term view. Which companies are solid? Which companies make money now and will continue to make money into the future? These companies are healthy, with revenue, earnings, good products, happy customers, productivity, good financials, and effective management. The health of the business directly contributes to the return of these investments.
What's Better, Trading or Investing?
In this simplified description, stock trading is a short term strategy. Investing is a long term approach.
They each have advantages. Stock traders provide valuable liquidity to the market. In plain English, you can only buy if someone's willing to sell and vice versa. If the market were composed entirely of people holding their investments for the long term, you'd have many fewer transactions.
From an economist's point of view, liquidity tends to smooth out prices so they move in smaller increments and have fewer dramatic swings.
Investing, on the whole, is better for companies. A public company has a board of directors responsible to shareholders, thus the needs of the shareholders are the needs of the board. Shareholder values guide the company's decisions.
When investors take a long view of the company's success over years—not individual quarters—management has more freedom to make decisions for long term success. The share price may get a minor bump from cutting research, but if that research would have helped produce new products or improve productivity in the next several years, it will hurt the company.
That hurts investors.
Remember also that short-term trading has to make up for taxes and fees, especially short-term capital gains taxes. Investors who take their profits after years can (at least in the US) avoid paying their top marginal tax rate on all realized gains, while traders who flip a stock after days or weeks will see their profits drop by a larger percentage.
Good traders can still make good profits, but they have to work a little harder for the money in return for the speed of the resturns.
Are you a Trader or Investor?
The choice is yours. Trading stocks takes time. You have to pay attention to market timing. You have the opportunity to make money fast at the risk of losing money fast.
Investing for the long term requires more research into company fundamentals, but you might go months or years without buying or selling. You still could lose money, due to fundamental changes in the business and not because of market timing.
The biggest risk of short-term investing is never knowing enough. "When the tide goes out," according to Warren Buffett, "everyone knows who's been swimming naked." Investing in great businesses—successful businesses with coherent long-term plans and histories you can count on—has made many successful investors out of people who were patient enough to see their investments through.