Investment tip: What is the difference between trading and investing

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Updated: July 24, 2015 1:30:47 PM

While purpose of investment is to build wealth, trading seeks to take advantage of temporary market events

An investor looks at the fundamentals of companies before buying the stock. A fundamentally strong company yields good results for a couple of years and is expected to do so in the future too.An investor looks at the fundamentals of companies before buying the stock. A fundamentally strong company yields good results for a couple of years and is expected to do so in the future too.

The difference between trading and investing was best illustrated by a stock market punter: “When I lose in a stock, I become a long-term investor. When I gain, I become a trader. This means when I lose on a stock, I hold it for some time to minimise the losses. When I gain, I immediately sell off the stock to take away the profit.” In reality, however, most often the reverse happens. The falling stock keeps falling while the profitable stocks keep surging despite a high valuation.

Trading or investing

The basic difference between trading and investing is of the time horizon. Typically, an investment is made for a long term. The purpose of investment is to build wealth. Trading is done for a short term, where the trader takes advantage of temporary market events to make money.

Secondly, an investor looks at the fundamentals of companies before buying the stock. A fundamentally strong company yields good results for a couple of years and is expected to do so in the future too. Essentially, an investor looks at the fundamentals of the company, projects a reasonable growth and then invests. On other hand, in case of trading, the trader is concerned with the short-term fluctuation in demand and supply of the stock. The tool most often employed by a trader is charts of various types, also known as technical analysis.

A trader buys for a short term; sometimes, even for a day — this is called intraday trading. There are other trading activities, such as short selling, options and futures that are meant. The tenure of options and futures is three months.

Investors’ objective

An investors must save and invest for a long term. This is the only way to build wealth in stock markets, unless an investor is an industry insider who is tipped of before making an investment. For most others, the sources of information are newspapers, television, intermittent tips through email and the Internet. Since information on these forums is publicly available, earning short-term profits on such news is quite difficult.

The best strategy for an investor is to select a few good companies and invest in them. If selecting right companies is difficult, investors can invest in a mutual fund (MF) with systematic investment plan (SIP). MFs invest in a set of select companies. All you have to do to invest in MFs is to talk to a mutual fund broker, fill up a form, or set up a trading account. SIPs allow investing a certain amount in the fund every month by automatically drawing it from the investor’s bank account.

Finally, investing is tax friendly too. If you invest in an equity for long term, you don’t have to pay any capital gains tax after one year. For the short term trader, the tax rate is as high as 15%.

Prospects of trading

Before trading in a stock, one must mark an amount for the purpose. For instance, one can demarcate 10% of his savings for trading. A trader must keep a track of the stock’s performance. Usually, he tends to remember a bumper gain and forgets small losses which, collectively, could surpass the bumper gains.

There have been stock market stories where people have made fortunes in momentum trading, options and futures, and day trading. However, these stories are few and far between. Trading requires undivided attention to the stock market dynamics.

Unless you devote significant time in understanding and analysing the stock market trends, stock volumes, prices and important events, it would be extremely difficult to make money. You may get lucky sometime, but the losses when you were unlucky would surpass your gains.

Tools of trade:

* An investor looks at the fundamentals of companies before buying the stock. A fundamentally strong company yields good results for a couple of years and is expected to do so in the future too
* A trader is concerned with the short-term fluctuation in demand and supply of the stock. The tool most often employed by a trader is charts of various types
* If selecting right companies is difficult, one can invest in a mutual fund with systematic investment plan
* Investing is tax friendly too. If one invests in an equity for over a year, he is not needed to pay capital gains tax

The writer is CEO, BankBazaar.com

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