The pandemic prompted thousands of people around the world to turn to the financial markets while they remained confined within their homes due to the possibly rewarding nature of participating in this fascinating money-making machine.
However, investing in stocks and other financial instruments is not as easy as it is often portrayed. For beginners, the first step toward becoming active market participants is to choose the approach they will be following when making their first transactions in the stock market.
They can either act as traders or they can opt for playing the role of an investor.
To clarify how each of these two approaches works, the following article digs deeper into the trader vs. investor dilemma to help beginners in picking a side before they start their journey.
Difference #1 – The skillset
The first difference between investing and trading is the skill set needed to be successful at any of these two activities. For traders, technical analysis is perhaps the cornerstone of their profession as they need to interpret charts accurately to identify potential trading signals.
Meanwhile, for investors, an in-depth knowledge of accounting and finance along with some degree of business wisdom is much more advantageous as their goal is to identify companies that will are poised to perform positively in the future.
Difference #2 – Time invested
Even though traders can be segregated into different groups depending on the maximum period that they hold a security, the most common ones consider themselves day traders. A day trader is someone that benefits from intraday fluctuations in the price of a financial instrument by using technical analysis to spot trading signals.
These traders will usually spend their entire day watching their computer screens and charts and that makes this activity a time-consuming one.
Meanwhile, for investors, most of their time will be devoted to analyzing a company´s past financial statements, market research reports, and other similar materials to determine the fair value of the underlying business.
That does not mean investing is not a time-consuming task, but time is invested differently for both approaches.
Difference #3 – Holding period
Whether they are day or swing traders, trading involves holding an instrument for less than a month. Meanwhile, that holding period is quite lower for high-frequency traders (HFT), scalpers, and day-traders who may only hold on to a security for less than an hour.
For investors, the most common approach is to buy and hold a financial asset for years as it often takes a lot of time for the market to fully realize the potential that the investor initially saw in the company.
Difference #4 – Risk tolerance
Any transaction made in the financial markets carries a certain degree of risk which means that both traders and investors are exposed to losing a portion of their money if a certain position does not perform as expected.
However, traders typically have a higher tolerance for risk as they are more exposed to the short-term fluctuations of the market than long-term investors. That said, professional traders tend to implement adequate risk management strategies that prevent them from facing steep losses.
These measures include setting a stop-loss order for their active trades, limiting the size of each individual position, and following a disciplined and systematic approach when picking which trades to make.
On the other hand, investors tend to be considered risk-averse individuals by nature. However, that is not necessarily true as, even though they typically hold their securities for longer periods, they could still be exposed to risky companies that may not perform as expected or whose businesses could experience a significant decline amid changes in overall market conditions.
Difference #5 – Taxation
Since traders open and close positions in relatively short periods, the gains they obtain from their activities are classified as short-term capital gains. This type of gain, in most countries, tends to be taxed at a higher rate compared to long-term capital gains, which apply to long-term investors who hold on to a security for more than a year before selling.
Now that you know the key differences between an investor and a trader, which approach do you think fits you the best?
By analyzing your current risk tolerance, skillset, and time available you will probably make a decision instantly as those aspects of your personality and life will easily tell you which activity you are best suited for at the moment.