Investing vs Trading What is the Difference?

There is a question sometimes asked by those new to the financial markets, and it is sometimes debated by experienced participants. The question is, what is the difference between trade and investment?. Because both trading and investment - when one looks at it from a financial market perspective - are done in very similar ways, it is often thought of as a dynamic transaction.

I have followed along with this basic article by presenting an idea of what separates the two is a broad definition. Both trade and investment, after all, are at a very easy level of capital expenditure. When I buy XYZ stock I expect to see the price rejoice or get shares - maybe both. What separates trade from investing, however, is that in trading one can often expect to go out. This may be in the form of a target price or depending on how long the position will be held. Either way, trading seems to have a limited life. Investing, on the other hand, is very open. The investor will buy the stock of the company without any pre-determined idea of when to sell, if possible.

We can use examples to show the difference. Warren Buffet is an investor. He buys companies that he feels are not respected in any way and holds on to his positions as long as he continues to love their prospects. He doesn't think the money will run out. George Soros was a trader (or at least while still running his hedge fund). His most famous trade was short of the British Pound when he thought the money was over and ready to be issued in the European Exchange Rate Mechanism. The position he took was based on a particular situation. When the Pound was allowed to float freely and was quickly lowered in the market, Soros came out with a good profit. That meets the conditions of having a pre-defined exit, which makes it a trade, not an investment.

There is another way one can define trading as a set against investment, however. It has to do with how the money spent is expected to generate a return. In marketing financial reporting is objective. You buy XZY stock at 10 expecting it to go to 15 and generate huge profits. If dividends or interest are paid overtime, that is fine, but only a small contribution to the expected profit.

In contrast, investing heavily depends on income over time. That makes revenue generation, such as budgets and bond interest payments, a major focus area. Do investors recognize financial appreciation? Sure, but unlike trading, that's not the main motive.

With these definitions in mind, consider what many people refer to as their one major investment - their home. Based on our second definition of investment, however, the home is generally not an investment because in most cases it does not generate any income. In fact, it generates huge costs in the form of mortgage payments, utility bills, and savings. If any, home is a business. We buy it and hope that its value will increase over time, increasing our equality. And the fact that many people expect to move in just a few years and sell at that time makes it more of a trade than an investment. (Certainly, your rental property can be considered an investment, unless the person investigates it, which would be more commercial).

As noted earlier, for most people the trade and investment seem to be the same. The buying and selling equipment is the same. Sometimes the analysis of a person's actions is the same when making such decisions. It is the purpose and definition of the goals that separate trade and investment.

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