Trading vs. Investing: Which is Better for Your Wealth Creation Strategy?

In the world of the stock market, we often hear about “trading” and “investing.” These are like 2 different roads to make our money grow and secure our financial future.

Trading and investing share a common goal: to enhance our financial standing, but they work in very different ways. They’re like different ways of playing the same game. Just like games have different rules and goals, trading and investing have their strategies and purposes.

Now, the big question is: What’s the difference between Trading and Investing?

How do you decide which path to follow for success?

What challenges might you face in each approach?

Let’s delve into these questions and explore the details. We will also study in detail the investor and trader point of view from a different perspective.

The best thing an investor can do is to gain knowledge and clarity before using his hard-earned money in the hope of wealth creation. It is more about the clarity you have in your chosen domain rather than what you choose. We promise you that, this article will help you clear the dilemma between Stock Trading and Investing and will provide you with insights to choose the best financial path for yourself.

Let’s get started!

Table of contents

1.)Navigating the Initial Question: Trader or Investor?

• Are Transitions for good?
• Handling The Dilemma
• The Ultimate Objective

2.)Trader Vs Investor: Sum Game

• Investing -Positive Sum Game:
• Investment Catalyst

3.)Trading -Negative Sum Game:

• Illusion Of Profit
• However…

4.)Exploring Wealth Creation: Investing vs. Trading

• Building Wealth: Mutual Funds VS Trading
• Long-Term Wealth Creation In Trading

5.)Dealing with Unknowns – Investing vs. Trading

• Impact Of Unpredictability On Investment

6.)Tax implications: Investing vs. Trading

• Taxes In Trading

7.)The Greater Fool Theory: Investing vs. Trading

• Trap Of “Escalating Valuations”
• How not to be a fool here?

8.)Evading through Market Dynamics: Investing vs. Trading

• Overconfidence – The Path Of Destruction
• Little Knowledge Is Dangerous

9.)So, what do we do?
10.)Conclusion

1. Navigating the Initial Question: Trader or Investor?

When you start your investing the first and foremost question that comes to your mind is whether you should be a trader or an investor.

On one hand, you would have seen many P&L statements on social media where the traders would boast of so many earnings in thousands within a short period and on the flip side you would see some long-term investors making 2X or 3X on their investments.

When we see such posts on social media we feel unsure about whether we should be a trader or a long-term investor or a bit of both. It happens a lot, doesn’t it?

This doesn’t end here.

• Are Transitions for good?

During bear markets, a trader may become long-term investors. In such situations, the traders may think of holding a stock for a longer period than they intended to.

The reverse also happens.

When a long-term investor sees a good movement in his stock, he suddenly turns into a trader with the mindset that the X% return so far is so good and may exit the stock.

• Handling The Dilemma

In both of the situations mentioned earlier, the investor’s actions are guided by the movements of the market. When this happens, the true aim of building wealth can become uncertain. It becomes challenging to be fully a trader or a long-term investor.

Therefore, it’s advisable to resolve this dilemma. It’s best to choose one path, either to be a committed investor or a trader. Trying to do both simultaneously might not yield the desired results.

However, if circumstances require it, you could consider having separate portfolios—one for trading and one for investing. This approach helps provide clarity on what actions to take. By doing so, you’ll have a clearer direction for your financial decisions.

• The Ultimate Objective

Whenever you engage in investing or trading, the primary goal is to achieve success.

Option A) You win

Option B) You do not lose everything

This ought to remain the core objective for everyone entering the world of stock markets.

However, driven by the desire for greater earnings, individuals often find themselves depleting their capital. A recent report from SEBI highlighted that 89% of individuals participating in derivative trading experienced losses.

In a Jan 2022 tweet by Nithin Kamath, Zerodha founder and CEO mentioned that only 1% of active stock traders make more money than bank fixed deposits (FDs) over a period of 3 years. He had also equated trading to someone who had started a new business where only a handful of people succeeded.

So why do people lose so much in trading?

We will now study various parameters to see which one between investing or trading helps us achieve the potential while minimizing the losses at the same time.

2. Trader Vs Investor: Sum Game

Let us analyze how people end up in losses by analyzing the cumulative effect or the sum games of the trading and investing styles

• Investing -Positive Sum Game:

What does it mean when you invest in stocks, bonds, or other assets?

It means that you’re essentially becoming a part-owner of a company or an asset. As the company or asset grows and succeeds over time, the value of your investment increases.

This growth benefits both you as an investor and the company or asset. It’s a win-win situation where all parties involved stand to gain.

For instance, if you own 1000 shares of ITC and if the company’s sales and reputation increase, your investment becomes more valuable, resulting in a positive return. You may also get periodic dividends from the company, and this may act as a source of alternate income.

• Investment Catalyst

The concept of investing is a catalyst for generating wealth. It involves a deliberate choice to allocate your funds to a financial instrument, like stocks, Mutual Funds, bonds, or real estate. Once invested, you patiently allow your chosen asset to appreciate over time.

This growth process is akin to nurturing a plant, giving it the time it needs to flourish before you gather its fruits. As the company flourishes, its value increases, and subsequently, the value of your investment grows as well.

3. Trading -Negative Sum Game:

“How is your trading going or haven’t you gotten started?” How often do you hear this from others? Trading has become so prevalent that the individual who indulges in it has a wrong assumption that everybody around them is Trading as well. This makes them susceptible to false beliefs.

Trading can sometimes resemble a Negative Sum Game. In trading, individuals often aim to profit from short-term price fluctuations in assets like stocks or currencies.

“In this scenario, for one trader to win, another trader has to lose”.

It’s like a zero-sum competition where gains for one party come at the expense of losses for another. This dynamic can lead to a situation where overall wealth doesn’t necessarily increase; it’s just redistributed among traders.

• Illusion Of Profit

For example, if you sell a stock at a higher price than you bought it, you make a profit, but someone else who bought at the higher price and sold at the lower price incurs a loss. Net-Net there is a win-loss in this scenario.

Traders aim to profit from short-term price fluctuations. They buy assets at lower prices and sell them when they believe the prices are higher, often within a shorter period.

This activity keeps the money “rotating” as it’s moved around frequently to capture gains from market fluctuations and there is no real money generation as in the case of investing.

• However…

This doesn’t imply that traders are consistently at a disadvantage, with only investors enjoying gains. Instead, this comparison of the overall impact aims to highlight the likelihood of safeguarding our capital from losses.

So, the lower the likelihood of losing our money, the higher the probability of achieving good returns.

4. Exploring Wealth Creation: Investing vs. Trading

Investing for wealth growth appears simpler initially. Unlike trading, investing relies on fundamental analysis and generally involves lower risks.

2 things matter here

1. Selecting the right stock or Mutual Funds
2. Holding onto your investments for at least a decade to see the real compounding.

Once you’ve built a collection of stocks, you can consistently invest in them through SIP in your stocks and Mutual Funds or by purchasing them during market dips.

This approach helps you ignore the stock market noise and stick to a disciplined strategy.

Since you’ve chosen stocks based on strong fundamentals, they offer protection against significant drops in value, safeguarding your invested money.

• Building Wealth: Mutual Funds vs. Trading

In Mutual Funds. you needn’t worry about stock selection as the fund managers do that for you.

For instance, imagine you have a portfolio of ten stocks. Even if six perform excellently while four don’t fare as well, your overall performance would likely outshine others who haven’t followed a similar strategy.

Furthermore, there are corporate actions like dividends and stock splits that can further contribute to the growth of your wealth over time. These actions add to your investment’s value and contribute to building substantial wealth in the long run.

Over the longer run the Mutual Funds also start to bear fruit. According to Research done by CRISIL, shows no single SIP gives a 0% return when it is invested over a longer time (10+ Years).

So you are not going to lose anything when you invest over 10 years. This is where the real compounding effects take place.

You will see substantial movement in your portfolio so much so that the per day gain in the portfolio may be equal to or more than your monthly SIP.

On the flip side, trading has a different story.

• Long-term wealth creation In Trading

The idea of quickly making a lot of money is attractive to many people who get into trading. While it’s true that you can make fast profits through trading, it’s not easy to consistently create wealth this way.

A single bad trade can result in substantial losses that are not easily recoverable. Moreover, the rapid pace of trading can expose us to sudden market shifts, external factors, and emotional decision-making, all of which may lead to wealth destruction.

Even though you might win some trades by doing many transactions, these wins are often offset by losses. This creates a situation where it’s hard to achieve lasting financial growth.

In the end, there is not much wealth created here unlike investing.

Hence investing scores over trading when it comes to long-term wealth creation.

5. Dealing with Unknowns – Investing vs. Trading

In both investing and trading, there are things we can’t control, like interest rates and big economic changes such as how well the economy is doing or the results of elections.

These things affect how much stocks are worth, but they’re hard to guess or handle. This is true for both investing and trading, but trading is more unpredictable because it happens quickly.

For example, if interest rates suddenly go up, it may momentarily impact for a few weeks. If you’re making fast decisions to buy and sell in just a week, unexpected things like this can make you lose money.

Big events like elections can also mess up your trading plans because the market might react in unexpected ways. These outside factors that we can’t control can make trading hard and cause losses.

One good example from recent times is the COVID-19 breakout which caused erratic movements in the markets. This may cause an emotional imbalance in the investor’s mind, and he/she may also not decide to participate further in the market.

• Impact Of Unpredictability On Investment

If you’re investing for the long term, these uncontrollable things don’t hurt as much

There might be some temporary effects, but they usually don’t mess up your investments in the long run. This is because these smaller events don’t have the power to stop your long-term plan for creating wealth and their impact is minuscule.

Even if there are any bigger events like COVID-19 or the great recession in 2008, they tend to balance out over time.

6. Tax implications: Investing vs. Trading

“In this world, nothing can be said to be certain, except death and taxes.”

– Benjamin Franklin

You might wonder about the influence of taxes on your portfolio, especially when considering the number of trades you make, whether in investing or trading. However, it’s important to realize that this can directly affect your overall CAGR.

Taxes and brokerages constitute a significant portion of your expenses.

When you invest for the long term, the taxes you pay are usually lower. You buy now and sell after many years, so you will be paying the LTCG once you sell the stocks.

You only pay a brokerage fee when you start and when you finish, with no costs in between. So, in general, it’s not as expensive.

• Taxes In Trading

When it comes to trading, the costs can be higher. If you’re trading often, like every day or every week, the expenses add up.

If you’re a trader, the tax rules are different, and you might end up paying more tax because your profits are counted as business income. You will have to show them as part of your ITR and have to pay the STCG

So, from a tax perspective, long-term investing is usually better, while short-term trading can be more costly.

7. The Greater Fool Theory: Investing vs. Trading

In the world of trading, there is a concept known as the ‘Greater Fool’. This concept revolves around a kind of competition to identify who among the market participants is the ‘Greater Fool’.

Let’s delve into a recent incident that vividly illustrates this principle. IPOs of highly anticipated companies like Nykaa, LIC, and Paytm generated substantial excitement across social media platforms. Consequently, numerous individuals applied for these IPOs and were allotted shares.

• Trap Of “Escalating Valuations”

However, once these stocks began trading on the stock exchange, they took a downward turn and experienced significant corrections. This can be attributed to the steep valuations at which they were initially listed.

This whole mindset is the trader’s mindset where you look to sell after listing, anticipating someone else would buy these shares.

Isn’t this a prime example of the greater fool theory in action?

In this scenario, the investors and the company founders escalated the valuations of these companies, leading to their listing on the stock exchange. Unfortunately, some of us would have fallen prey to these sorts of gimmicks.

• How not to be a fool here?

But you can change the entire scenario by being a prudent investor.

As an investor, you would plan to hold these stocks for a longer period, say 10 years or so.

In that case, you would have studied the fundamentals in depth and the various ratios, and you may not have opted for such high-valued companies had you seen them from a long-term investor point of view. So, in this way, you are not being fooled nor you are fooling others as well.

8. Evading through Market Dynamics: Investing vs. Trading

Before delving into discussions about market dynamics, let’s pause and ask ourselves a fundamental question.

How many of us can truly predict unpredictable events in the stock market, such as the Covid crash, the 2008 bubble burst, or the recent Russia-Ukraine war crisis?

We might have some insights, but can we accurately forecast the exact percentage by which Nifty or Nasdaq will decline?

The reality is, NO one can.

If there were such a person, they would be the ultimate trading expert, capable of pinpointing turning points and shifts in trends with precision.

• Overconfidence – The Path Of Destruction

Since none of us can foresee these events, trading carries a higher risk, potentially leading to capital erosion. You might wonder, though, that from May 2020 to November 2021, the markets only seemed to go up, benefiting traders. Is this not a case in point?

Indeed, it is. However, in hindsight, many individuals were caught up in the market’s momentum and might have felt like they were becoming stock market geniuses by profiting from frequent buying and selling.

This illusion, however, shattered when the market began correcting in November and extended into December 2021.

• Little Knowledge Is Dangerous

Both investors and traders can taste success when the market is on an upswing, yet it’s vital to discern whether it’s their expertise or the favorable market conditions driving their gains.

Long-term investments don’t solely rely on personal abilities; they’re positively influenced by long-term market performance.

On the flip side, short-term trading can appear lucrative during bullish markets, but this success could owe more to market trends than individual trading skills.

As prudent investors, we mustn’t be swayed by such illusions. Instead, let’s stay the course with our SIPs to steadily build our wealth.

9. Trading vs Investing: So, what do we do?

Now that we all realize the answer to the question “ Which is better, Trading vs Investing?” and how investing can reduce our probability of capital erosion, what should be our next step here?

We should invest in quality stocks and choose the right Mutual Funds for the long run. There are many criteria such as how to select the good fundamentally strong stocks and funds for the longer run using the different scanners.

Investing in the long term is not only about making money gradually but also about making your investment less risky.

One way to do this is by SIP. SIPs also allow you to take advantage of times when the market is down, and stocks are cheaper. You can get stocks at much lower prices and can accumulate more units in your Mutual Funds at a lower NAV.

For example, during the big financial crisis in 2008 and the market drop in 2020, smart investors who were thinking long-term saw this as a chance to put more money into their investments. This made their yearly growth rate even better.

10. Conclusion

“Stay invested in your investments no matter what the market is doing”.

This means keeping your investments even when the market is going down (corrections) or when it’s going up a lot (bull markets). This way, you’re ready to get good results from both the times when the market is doing well and when it’s not. This helps you have a strong and flexible investment plan.

Are you searching for answers to investment and finance-related doubts on social media platforms like Quora, Facebook, Twitter, etc.? A professional Financial planner who has better experience and knowledge can guide you better towards your financial goals.

Happy Investing!