How is trading different than investing?

Difference between Trading and Investing

After I wrote my last post, many readers were interested in understanding the difference between Trading and Investing.

This post is an attempt to understand how trading is different than investing (in stock market).

Cricket being most popular game in our country, let me use the same analogy here. All of us know the difference between T20 Vs One day. One is short term form while another is little longer. T20 offers its own thrills while One day has its own charm.

Similarly both, investing and trading have their ‘good’ and ‘bad’.

Let’s understand them one by one-

Investing:

Investors usually choose Value Stocks (stocks which are available today at a cheaper rate and are expected to grow in value in next few years) after doing research.  The research can include fundamentals about company. Investors buy these stocks and keep them in their kitty for long term. Investors put limited amount of time in researching the stocks. The holding period usually spans from 1 year to several years. Investors are not bothered about short term fluctuations in stock prices. Investors can earn good returns when the markets are rising. Limited buying selling transactions take place. Investors may buy these stocks by aiming specific life goals like retirement.  

Let’s take an example. One share of HDFC Bank was costing at Rs.200 in 2008. Today one share of HDFC Bank is costing approximately Rs.650. So this stock has generated return of 225% in 5 years. Per year return are approximately 45%. So to earn the return of 225% only two transactions took place. Buying in 2008 and selling in 2013.  

Trading:

Trading, on the other hand, is short term buying or short selling activity to earn profit. The span of a trade is usually from 1 day to six months. Traders use tools like Technical Analysis to predict short term moves of the stock. Traders believe in booking the profit in decided time span. If the stock is not moving in the expected direction, traders exit that stock and enter into another trade. Large number of buying-selling transactions are executed. Traders can earn profit in rising as well as falling markets. (Read my article ‘Investing in Futures’ to understand how you can earn in falling markets). Traders spend lot of time every day to analyse the market moves for coming days or hours.

You may not trade with an amount which is kept for specific goals in life, but the one which is a buffer and you would like to earn better than best returns at the cost of some extra risk. It is like generating extra income source through trading of stocks.

Let’s take an example. A Trader was bullish on Tata Motors which was trading at 270 on 27 June 13. Trader decides to buy Tata Motors as his research tells that it would move higher at or around 300. The stock achieves desired price on 25 July 2013. Here trader decides to book profit. The profit is 11% in the period one month. Immediately after this period, trader’s analysis tells him that the stock would move down to 280 in next few days. Here a trader would short sell the stock on 25^th July and buy it back once the stock achieves price of 280 on 31 July, thus earning 6.6% profit in duration of 4 days.

Trading is strongly supported by advancement in Technology like online terminals, various technical analysis tools, trading advisory services, margins offered by brokers, lot of information on internet etc. 

Finally, you need to decide which one suits you.