Financial markets may provide many opportunities for those interested in them and there are many approaches to exercise, the most common ones being trading and investing. Anyone who takes trading seriously needs to know the answer to the question “what is trading” and be able to explain how it works. In this article, we will learn about the pros and cons of trading and investing, as well as their similarities and differences.
What is trading?
In short, trading is the act of buying and selling of securities (for example, stocks, currencies, commodities, cryptocurrencies, etc.) with the intention to speculate on the difference between the purchase and the sell prices. Generally, traders aim at buying cheaper and selling higher. Trading is normally performed on shorter timeframes, in contrast to the buy-and-hold approach of investors.
In regards to market analysis, traders often choose technical analysis over fundamentals, since it allows for more short-term indications and, sometimes, more precision. Traders use indicators and other technical analysis tools to find potential entries and detect breakthroughs and pullbacks.
One of the most popular trading approaches is the intraday method where trades are opened and closed within the same day, or even within minutes or seconds. Traders that choose day trading as their main approach are required to be fast, attentive and precise. This method can give quick results, since deals are opened and closed within the same day, however, it is also risky due to the volatility of the assets. There are several ways of trading intraday: scalping, breakout and reversal trading.
Scalping allows traders to speculate on the smallest changes in the price of the asset. With this approach, traders usually make numerous short-term trades of 1-5 minutes. They keep the investment amount small and count on accumulating positive outcomes over a series of deals, instead of making one big trade. This approach suits traders that prefer fast-paced trading, favor quick results, and have high risk tolerance.
Breakout traders rely on the support and resistance lines for entry and exit signals. This approach is based on the notion that when the asset price reaches the support or resistance area and breaks through, the trend is strong and might continue moving in the same direction. Usually, when the price breaks through the resistance line, traders may buy, and when the price breaks through the support line, traders may sell.
Another method based on the support and resistance lines is the reversal approach. Traders look for conditions in which the price bounces off the support or resistance level and reverses. This could be a signal to enter a buying or selling position, respectively. Such short-term reversals are particularly useful for intraday traders.
Trading pros and cons
There are many methods that can be exercised in trading, and all of them have their advantages and disadvantages. Understanding them can help an individual make a decision whether or not trading suits them.
Some of the advantages that trading has over long-term investing are short timeframes, lower investment costs and possibly more entry opportunities. Trading is preferred by those who do not have a large sum of money to invest. It also provides flexibility: the possibility of trading different assets at once, without having to choose particular ones to invest in. Trading is practically the opposite of “putting all eggs in one basket”.
However, trading also has its cons. Trading is risky, therefore, a strong money management approach and risk tolerance are needed. It requires good technical analysis and quick decision making in order to spot opportunities. Another disadvantage for some traders is how time consuming trading can be — it requires a lot of effort and close inspection of the market conditions.
Investors have the same goal as traders: speculate on the difference between the purchase and sell price of the asset. However, investors commit to longer timeframes — an investor might purchase a stock and hold it over a significant period of time (a month, several months or even several years). It is worth noting that investors are usually buyers, while traders may trade both long and short positions.
Usually, investors focus on fundamentals, since they play a significant role in the long-term perspective. They tend to prefer assets with long-term potential and they are ready to overlook short-term losses — something that a trader will not do. While traders sometimes execute a news trading approach, investors value solid indicators, not short-term sensations. Investing is also associated with a large starter capital, since building a well-diversified portfolio can be quite expensive. If the assets of the portfolio were masterfully selected, this might have a positive outcome in the future, but it is not an approach that is easily available to everybody and carries many risks.
Investing pros and cons
One of the main advantages of long-term investing is the possibility of managing risk more effectively. Investors make fewer deals than traders and do not use leverage. They also tend to spend more time on the diversification of their portfolios. Investments are rarely affected by short-term pullbacks either, since investors keep them for several months or years. With that said, investing is by no means a safer approach than trading, since it also puts one’s capital at risk.
Another possible advantage of investing is the more hands-off approach, at least in comparison with trading. Investors spend a lot of time thinking about their next purchase, but once it is done, they keep the security until it’s time to sell, they do not make tens or hundreds of deals in one day.
Among the disadvantages of this type of market participation are higher costs — buying shares or other expensive assets will require a large capital investment which is not readily available to everybody. Another con is the timeframe — investing takes a lot of patience and the possible returns heavily depend on the start-up capital.
To answer the question “what is trading”, it is important to understand the difference between trading and investing. While it is not uncommon that investors occasionally trade short-term timeframes, and traders occasionally invest long-term, generally these two approaches are polar opposites. Each one of them has its advantages and disadvantages, and each can choose their preferred approach, or combine the two.