Investing vs. Trading: What's the Difference?

Upbeat music plays throughout.  

Narrator: When we think about people who invest in the stock market, two types generally come to mind: investors and traders.

The stereotypical image of a trader might be the frenetic floor trader, yelling orders across the trading pit, sleeves rolled up.

Traders generally buy stocks with the intent to sell when the price reaches a particular point, usually within a short time frame, in hopes of making a quick profit.

On the other hand, an investor might be the white-haired guru who knows everything about the guts of a company and focuses on building a portfolio that grows over time.

Investors generally buy stocks and hold them with the expectation that they will grow in value and for the purpose of generating income via dividends, which are regular payments of profit to shareholders. Typically, they don't intend to sell good stocks, even when times are bad.

Now, these may be extreme stereotypes, but they do represent some key differences between the two types.

You might now be asking: Am I a trader or an investor? Which one is better? How do I know?

To answer these questions fairly, let's evaluate traders and investors in an apples-to-apples comparison. This can be done by breaking down how traders and investors differ in three main ways:

Time frame, activity, and risk management.

While there are some common elements, traders and investors approach these elements in a slightly different way.

First, let's dissect how traders look at time frame, activity, and risk.

Traders typically look at the market as a place to seek quick, short-term gains. Their goal is to figure out how to get in and get out of a trade with maximum profits so that they can do it all over again.

This "do it all over again" attitude typically results in traders having a shorter time horizon for buying and holding stocks compared to investors.

Second, traders' activity levels are different. Activity means trading, and a trader needs to know when to get in and get out of a trade. For many traders, this means analyzing price charts and other signals. Reading charts to know when to buy and sell a stock is often called technical analysis.

On-screen text: Investing involves risk, including the loss of principal invested.

Narrator: Finally, there's risk. When it comes to risk, traders often see risk in light of the probability of success of the particular trade. Traders often use stop orders, or exit points, and price targets to create trades that have defined risk, which helps them calculate the probability of success.

Now that you know how traders approach time, activity, and risk, let's look at how investors do.

Because investors want to generate earnings from the appreciation of the investment AND from dividends, their time frame may be considerably longer than that of traders. In fact, investors may simply buy a stock and hold it indefinitely, with no plans to sell based on time.

Just like traders, investors have some means to determine when to enter an investment. Often, this decision is based on a company's overall health, which is determined by looking at its quarterly earnings report and balance sheets, income statements, and financial reports.

But unlike traders, investors typically don't have a specific plan to exit the stock at a particular price. For investors, risk management is a function of picking the correct investment in the first place. Price fluctuations are simply an acceptable part of a stock's life. And if the stock price does drop, investors tend to believe that it will go back up over the long haul.

The amount of activity that investors engage in is generally much less frequent than that of traders and is often confined to simply adding new stocks to a portfolio over time.

If you're asking yourself, "Am I a trader or investor?" you're not alone. Let's answer this question by exploring "what if?" scenarios.

You might be a trader if you like the idea of buying and selling stock, if you buy based on expected price movements, and if you have no real interest in the underlying company beyond the movement of its stock price.

On the other hand, you might be an investor if you have a strong conviction about the long-term prospects for a company's growth, or if you're uncomfortable jumping in and out of the market based on short-term price changes.

So, which one are you?

Over time, you'll find that you tend to lean one way or the other, but you probably have some elements of both types.

You may have a large part of your portfolio in long-term investments where you act like an investor, and you may have another, likely smaller, portion of your portfolio dedicated to active trading.

When it really comes down to it, the answer to the question "Trader or investor?" may simply be, "Yes and yes."

On-screen text: [Schwab logo] Own your tomorrow^®