What is the Difference Between Trading Stocks and Investing?
There's a lot of jargon in the investing world. Most of it is straightforward, but some of it depends on the philosophy of how you buy and sell stocks. This is a combination of your appetite for risk, the effort you want to put into the process, and what kind of profit you want to pursue, as well as subtler motives like the ethics of where you place your money.
While there are many schools of thought, there are two very broad categories: traders and investors.
What is Stock Trading?
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 he or she believes there is a short term advantage to do so.
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 believe that the price per share is wrong and will be corrected soon to the trader's advantage.
If you're asking yourself "Who does this trader make money from?" and if you're feeling a knot in the pit of your stomach that it might be you, then you're right. Day trading is a great way to lose money.
What is Investing?
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. (Assume she reinvested her dividends). Over that sixty year period, she turned a little bit of money into a lot of money thanks to patience and compound interest and owning a really good 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 people know what makes a company healthy: revenue, earnings, good products, happy customers, productivity, good financials, effective management. The health of the business directly contributes to the return of their investments.
Is Long Term Investing Better than Short Term Trading?
They each have advantages. Stock traders provide valuable liquidity to the market. In plain English, if there's a small army of people willing to buy something you're selling, you'll have an easier time selling it. Similarly, if there are a lot of willing sellers, you will have less trouble buying it. If the market were composed entirely of people holding their investments for the long term, you'd have many fewer transactions. (If you're into economics at all, you can probably imagine that this liquidity tends to smooth out prices; prices should move in smaller increments.)
Investing, on the whole, is better for companies. Because a public company has a board of directors responsible to shareholders, the needs of the shareholders are on the minds of the board. Those needs should help to guide the company's decisions. When investors take a long view of the company's success—on the order of 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 actually hurt the company.
Should You Be a Trader or Investor?
The choice is yours. Trading stocks takes a lot of time and means you have to pay attention to market timing. You have the opportunity to make a lot of money fast, but you also take the risk of losing a lot of 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, but 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." Whereas by investing in great businesses—successful businesses with coherent long-term plans and histories you can count on—has made many successful investors. At least, if they were patient enough to see their investments through.