New people to financial markets always ask, and experienced participants always debate the same essential question. The question being how you differentiate between trading and investing. Trading and investing are performed similarly and often thought of as interchangeable.

Scope definition is the only difference. When it comes to profit, they are the most simple application of capital. If I buy a stock, I expect either to see the price increase, or to earn dividends. In trading, one generally has an exit expectation. This might be in the form of a price target or in terms of how long the position will be held. Trading has a finite life. However, investing is open-ended. An investor buys a stock with no intention, or notion of selling.

For the sake of demonstration, here is an example. Warren Buffet is an investor. He buys a company that is undervalued, and holds on to his positions until he stops liking their prospects. He doesn’t think in terms of a price to exit the stock. George Soros is a trader. He thought the British Pound was overvalued and ready to be withdrawn from the European Exchange Rate Mechanism. His position was based solely on circumstance. Soros exited with a good profit when the Pound was devalued in market. Because an exist strategy was in place, this would qualify as a trade.

There’s another way that you can define trading. It has much to do with the manner in which the capital is expected to produce a return. In trading, the appreciation of capital is the objective. If you expect a stock at 10 to go to 15, you expect it to go through a capital gain. If dividends or interest are paid out along the way, that’s fine, but only a small contribution to the profits expected.

Income over time, however, is investing. Dividends and bond interest payments are a major focal point. Investors can experience capital appreciation? Yes, but unlike in trading, that isn’t their prime motivation.

Consider what people think of as their biggest investment, being their home. A home doesn’t produce income, though, so is it really an investment? It definitely produces more expenses, with electricity, upkeep, and mortgage. A home is a trade. We buy it and hope it’s value will appreciate. People generally move in for a few years, then sell, which makes it more like a trade. If, of course, you own rental property, it is more of an investment. As mentioned earlier, trading and investing seem very similar. Selling and buying are pretty much the same when it comes to mechanics. Sometimes the analysis that a person does to make decisions is the same as well. Investing and trading are merely different because of definition.

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