Except for finance professionals in the investment world, most of the rest of us assume that investing and trading are one and the same thing. It is not rare to find someone using the two words interchangeably in a statement as if they are synonyms. However, the two words have different meanings and they are two different concepts which have a few similarities nevertheless. Investing generally is a long-term view of wealth creation while trading is a short term view of making gains from the rising and falling of prices of the investment instrument you are buying or selling.
For investors, the focus is on a concept called value investing which was advanced by the respected US investor Benjamin Graham. Ben Graham was also the mentor to Warren Buffet who is the global icon today in stock investment. Under the concept of value investing, the investor does what is called fundamental analysis of the market to identify the intrinsic value of the stock they want to buy. After calculating the intrinsic valuation of the stock, the investor will then wait until the market undervalues the stock to make a purchase of the undervalued stock.
The whole concept of value investing is based on the belief that all traders are irrational and they overreact when making trading decisions based on good and bad market news. As such, the resulting stock price from the forces of supply and demand is not always the intrinsic value of the stock. In the long-run, investors believe that the stock will overshadow the market overreactions and its price will correct itself towards the intrinsic value. It is based on this premise that investors look for stocks they believe are undervalued and invest in them for the long run as they wait for their prices to get to their intrinsic values.
Once the stock the investor holds goes beyond its intrinsic value, it is said to be overvalued and the investor then sells it and earns the margin between the price they bought it for and the price they have sold it at. It is a common belief amongst value investors that you make your money when buying and not when selling. The goal is therefore to always find the most undervalued stock based on its intrinsic valuation from your fundamental analysis and buy it at the that lowest price; then sell it later when the price corrects itself to or beyond the intrinsic value. In its very nature, investing is a low risk undertaking.
On the other hand, for traders the focus is on making quick gains from the day to day price movements of the stock being traded on. Traders can follow a strategy called technical analysis in making predictions about price movements of various stocks and hoping to gain from them. In essence traders make money through speculations. To make their speculations more informed, they use charts to track the stock prices and use the trends formed by the price movements to predict the next movement in the price of the stocks they are trading in. Their predictions then inform their buying and selling decisions.
Traders are also very keen on market news too and often use the news from the market to predict the way their charts will move in the short-run. If good news about a company comes up they assume that the market will reward the company by buying more of the shares of the company. This will then push up the demand for the particular stock relatively higher to its supply and hence result to an increase in its price. With that assumption in mind, traders then buy the stock of the company that releases good news into the market and sells it when the price rises. On the other hand, if bad news hits the market either from a specific company or on economic and geopolitical sectors, the market slows down and prices fall as traders sell off most of their holdings. This makes trading a very risky venture due to the random price fluctuations in markets.
However, with the new generation of trading companies, even beginners can start trading in controlled environments where their risk is moderated. Companies such as Avatrade.com offer automated trading programmes that moderate risks for beginners. They also offer experienced money managers who support beginners in trading based on their risk appetite as thy learn more about the market. Another strategy that can be used to by new traders is the stop-loss options which are available in the new generation of trading companies.
Taken together investing and trading have their own outstanding differences. However, in both cases you need to analyze the markets before getting in. In the end, you might want to begin with investing, but if you want to get regular returns from market movements, you will soon find yourself venturing into trading. Done together, investing and trading can be used to construct a well-balanced investment portfolio with evenly distributed returns and reduced risk exposure. This will eventually improve your personal finance and lead you to your path of financial freedom.