A common misconception is that trading and investing are synonymous. As a result, investors frequently attempt to increase their wealth by implementing different trading tactics. However, trading and investing are two rather different strategies that people can use to profit from equity investments.
Determining which type would be most effective for you requires an understanding of the basic distinctions between trading and investing.
We will go over the key distinctions between trading and investing in this blog, including the holding period, the effect of compounding, and return taxation.
What are investing and trading?
Trading is the activity of quickly purchasing and disposing of financial assets, such as stocks, commodities, or currencies, in order to profit from price changes. By taking advantage of market volatility, traders hope to make rapid profits.
Purchasing financial assets and holding them for years or even decades is a long-term strategy known as investing. The objective is to progressively increase wealth through compound interest, dividends, and capital growth.
Important Distinctions Between Investing and Trading
Factor |
Trading |
Investing |
|---|---|---|
| Horizon of Time | Minutes to months is a short-term | Long-term, ranging from years to decades |
| Level of Risk | high as a result of market turbulence | Less than trading |
| Method of Profit | Short-term changes in price | Long-term dividends and growth |
| Type of Strategy | Regular purchasing and selling | Purchase and hold |
| Basis for Decisions | Technical evaluation | Basic analysis |
Trading Has a Shorter Holding Period Than Investing
The interval between purchasing and selling an investment is known as the holding period. Stocks are kept for brief periods of time, ranging from a few hours to several months, when trading. The concept is to purchase stocks at a discount and sell them for a profit when the stock price increases by taking advantage of the short-term volatility of equity markets.
An investor, on the other hand, is someone who plans to hold onto their investments for a number of years or even decades. Giving investments time is the main goal; even in the event of brief volatility, you should just wait it out without taking any action.
When trading, the power of compounding is not available to you.
Finding the next profitable deal is the main goal of trading, thus it’s important to keep buying and selling. You lose out on compounding’s potential because of this little holding time and rapid churn. Compounding is not the cause of trading’s ability to provide returns.
However, as an investor, you allow the power of compounding to work for you since you keep your investments for long periods of time. Additionally, this compounding force has the ability to magically increase your wealth tenfold over time.
When trading, your tax outlay on returns is higher because capital gains taxation applies to all equity-oriented assets equally.
However, the taxes you pay in trading will usually be higher than in investing because of the difference in how you create returns. Here’s why.
As a trader, you will hold equities for a few days to a few weeks at a time. Traders rarely keep equities for longer than a year. The returns produced will therefore be categorized as Short-Term Capital Gains (STCG). At the moment, equity-oriented investments are subject to a 20% STCG tax rate. Therefore, you will pay 20% tax on your returns regardless of the amount you generate.
However, when investing, you will be concentrating on holding the investments for extended periods of time. As a result, you won’t cash in within a year of investing. The returns will therefore be recorded as Long Term Capital Gains (LTCG) when you do redeem. For equity-oriented investments, the current LTCG tax rate is 12.5% on returns over Rs. 1.25 lakh for a fiscal year.
Therefore, you are exempt from paying taxes on LTCG up to Rs. 1.25 lakh in a fiscal year. Returns are subject to 12.5% taxation only if they surpass the Rs. 1.25 lakh level in a fiscal year.
Investing vs. Trading: Which Approach Is Better?
- Answering these four important questions will help you decide if trading or investing is a better way to build wealth for you:
- Are you naturally eager and would rather be actively involved in trading in order to make quick money?
- Do you possess the skills required to conduct in-depth technical analyses of several equities in order to select the best trade?
- When making a trading call, are you able to dedicate the necessary time to actively analyzing a range of real-time market data?
Do you have the risk tolerance to continuously jeopardize your investing funds in an attempt to turn a profit quickly?
You may have what it takes to be a great trader if you answered “yes” to every question above. Although trading can be an exciting method to make quick money, you must remember that the dangers are far higher than those of long-term investments.
It is normal for some of your judgments to be wrong when you buy and sell stocks several times in a short period of time. For this reason, traders attempt to win large by taking on a lot more risk. Long-term investors, on the other hand, can choose to hold onto their investments for longer periods of time in order to ride out short-term volatility, use appropriate asset allocation methods, and make periodic portfolio modifications in order to reduce portfolio risk and maximize total returns.trading and investing
The bottom line
The long-term advantages of remaining invested for the typical person greatly exceed the trading profits in the short run. As a result, trading may appear like a more interesting approach to increase your wealth than long-term investing. However, if you choose to invest, you will have to devote a lot less time and effort and take fewer risks in order to increase your wealth over time.
