Trading and investing both involve seeking profit in the stock market, but they pursue that goal in different ways.
Traders jump in and out of stocks within weeks, days, even minutes, with the aim of short-term profits. They often focus on a stock’s technical factors rather than a company’s long-term prospects. What matters to traders is which direction the stock will move next and how the trader can profit from that move.
Investors have a longer-term outlook. They think in terms of years and often hold stocks through the market’s ups and downs.
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“Traders often take advantage of small mispricings in the market.”
Timing is the starkest difference between traders and investors, but their focus also differs dramatically.
Investors study a company’s potential for long-term growth or value, but traders often take advantage of small mispricings in the market, such as when political uncertainty in a foreign country temporarily pushes down the share price of a U.S. manufacturer.
So-called scalp traders might be in a position for just minutes. Day traders are focused on the trading day, while swing traders invest for days or weeks.
“Once the temporary mispricing is corrected, a trader will move on to find the next temporary mispricing,” says Ryan Bayonnet, founder of Hyland Financial Planning in Akron, Ohio.
If you're interested in trading, here are some tips for minimizing risk:
Create a plan that dictates when you’ll buy and sell. For example, you might decide to sell if a stock rises or falls a certain percentage.
Stick to your plan. Even experienced traders let their reasoning for holding certain stocks shift. “That’s the hardest part of being a trader, sticking to your rules,” says Matt Saneholtz, a former professional trader and now co-owner of Tobias Financial Advisors in Plantation, Florida.
Figure out how much money you can afford to lose, and don't trade more than that. Larren Odom, founder of Chastain Wealth Management in Atlanta, suggests trading no more than 5% of your investable assets.
Go in with open eyes. “The most advanced traders use sophisticated algorithms to trade on any small inefficiencies in the market,” says Kirsty Peev, a portfolio manager at Halpern Financial in Ashburn, Virginia. “The margin of opportunity is so slim now. They may be aiming for a 0.01% gain on millions of dollars. The average person is priced out of this playing field.”
Know your taxes. You might be able to take a tax deduction for trading costs, but you might also owe taxes. Rates on short-term gains range from 10% to 37%. See what you’ll owe on short- and long-term capital gains.
» For tips on how to day trade, check out our guide to day trading safely.
Investing is a way to build long-term wealth. Just ask anyone who bought stocks in March 2009 — the Standard & Poor's 500 index is up about 250% since then. A recent NerdWallet study shows investing in the stock market can return millions more retirement dollars than putting money in a traditional savings account or keeping it in cash.
Here are tips for doing it right:
Create an investment plan for buying, selling and rebalancing your holdings. For example, some people sell some holdings and buy others to get the portfolio back in line with original goals after market moves have pushed it out of whack.
Be prepared for the long haul. You’ll need patience and discipline to stick through the market’s ups and downs.
“Trading may feel good in the short-term,” says Brian Schaeffer, an advisor with ShankerValleau in Skokie, Illinois, “but as an investor, time is your best friend.”