In the world of finance, we often hear the words ‘trading’ and ‘investing’ used interchangeably. However, although investors and traders are both attempting to profit from the financial markets, both methods pursue that goal in different ways. Here, we’ll provide an in-depth look at the differences between physically buying company stocks and simply trading on a stock’s price movements.
Stock trading is a long-term investment strategy. As a result, investors will usually hold a position for years or even decades. In doing so, those involved in stock trading will attempt to profit from price changes and dividend payments (this is an amount paid by companies to shareholders that depends on company performance). Usually, investors will aim to achieve returns of 10%-15% annually.
The long-term value of this strategy can be seen through the history of Standard & Poor’s 500 index, which is a popular measure of the US stock market. In the Obama years (2008-2016), the index returned 235%, which is 16.4% annually. Similarly, on an individual company level, anyone who invested in Apple stock in 2009 would have seen total returns of over 1,200% by 2019.
Due to this, investors will normally ride out any short-term losses in the belief that these losses will be recovered in the long term. This is because investors are more concerned about market fundamentals like management forecasts and price-to-earnings ratios than they are about day-to-day performance and individual earnings reports.
By contrast, traders can take positions that allow them to profit in both rising and falling markets. This means they can ‘go long’ and ‘go short’. As a result, traders take short-term positions that focus on smaller market movements. For this reason, some traders will only hold positions for minutes or even seconds. In doing so, they’re attempting to take advantage of volatility around key events in the earnings season report calendar, which is when many public companies release their earnings and show how they’ve performed against expectations. When earnings are released, we usually see a great deal of volatility in a company’s stock price, as market sentiment adjusts to reports. As a result, by taking short-term positions in a volatile market, traders believe that they can outperform the results of traditional buy-and-hold investing.
Historic events show this is possible. For example, in 2008 when Porsche announced it had acquired 74% ownership of Volkswagen, some shares sold for £1,000 and Volkswagen’s share price jumped by 147% in a single day. Similarly, when tech company Zynga announced it had missed its projected earnings, the company’s stock price fell by 40% during the day’s after-hours trading, with traders ‘going short’ on the company profiting and investors losing out.
When stock trading, investors physically buy the asset in question. Due to this, they take long-term positions in the market, adopting the mantra of buying low and selling high (this is known as ‘going long’).
By contrast, a trader will use a derivative product that takes its value from the price of the underlying market. As a result, traders do not physically own stocks or shares in a company, which means they do not have shareholder rights or receive dividends. Traders will trade shares whether by spread betting or CFD trading.
Risks and charges
When you invest in stocks, your risk cannot exceed your initial outlay, even if the company you’ve invested in filed for bankruptcy or goes out of business. So, if you invest £500 in a company’s stock and the value falls to £0, you’ll still just lose £500.
However, when it comes to trading, many traders open positions using leverage. This means that they only require a fraction of the total trade value for their initial outlay. Many do this because it maximises profits, but it can also magnify losses and means traders can lose significantly more than their initial outlay. To counter this, some traders use tools like stop losses to manage risk.
It’s important to remember that investing and trading both have their positives and negatives. As a result, you should do your research carefully before you decide which strategy is right for you. In addition, before you begin investing or trading, you should make a detailed plan that outlines your intent and strategy. Financial markets move quickly, and you should never lose sight of what you’re trying to achieve.