Are You Investing or Trading?
I've been getting tons of questions from readers about what apps to use for investing. My answer always begins with the question, "What's your goal?". Often I receive mixed answers and confusion stemming from a lack of understanding the differences between investing and trading in the stock market.
Usually, the word "investing" gets used as a blanket term for any buying or selling of securities through the "stock market".
What is the Stock Market?
Investopedia defines the stock market as:
An exchange is really just a prescribed place where people can buy and sell securities on the secondary market. It just happens that these places have taken root in well-known locations such as Chicago, New York, Hong Kong, Sidney, etc. So we can choose to participate in buying and selling securities (stocks, for example) on this secondary market exchange commonly known simply as "the stock market".
What is Trading?
So, how do you know if you're trading or investing? You need to understand what trading is first.
Trading, or day trading, is a short-term generally fast-paced activity in which a market participant attempts to buy and sell securities at an advantageous price. There are many strategies or approaches one could take when trading securities on the stock market. All trading strategies, however, rely on some variation of a concept known as arbitrage.
Somehow you must purchase a financial instrument for less than you will sell it for. Because trading is short term, traders aren't relying on overall market inflation to raise the price of their security. Traders buy stock when it's out of favor, on bad news, because of an indication on a technical chart, or other niche factors. They then attempt to sell that same security at a higher price due to some form of the price discrepancy.
What is Investing?
According to Etymonline, the term "investment" originated in conjunction with the East India Company in the early 1600's. It refers to, "the conversion of money to property in hopes of profit".
In today's world, investing your money is a longer-term prospect than trading in the markets. Investing takes a longer time horizon, and this is the biggest difference that is all too often overlooked. This seemingly insignificant difference in terminology makes a major impact.
While the exact time frame that defines the difference between "investing" and "trading" is impossible to pin down, I'm going to ballpark it around a year. Buying and selling a security in less than a 12-month window is probably more akin to trading than investing. Transactions of securities of 12+ months can be considered an investing approach.
Why Bother Defining Time Horizons?
So why do I differentiate between investing and trading? Sure, we could call them both investing or both trading - as they fundamentally are the same. However, it helps me to just have a mental barrier between the two.
Why? Because approaching a short-term trade with the mentality of a long-term investment can be brutally dangerous. Or vice-versa.
The apps we use for long-term investing are different than the apps we might use for trading.
For example, Robinhood is great for short term trading thanks to the lack of commissions and simple interface. It's terrible for long-term investing, however. Robinhood only features a simple brokerage account and no IRA or other longer-term advantaged account types. On top of that, there are no automatic rebalancing features, and the constant price movement alerts play on users emotions to buy and sell on a whim.
On the other hand, M1 Finance is hard to use for short-term trading. Its automatic rebalancing is much more suited to taking advantage of modern portfolio theory as it applies to a long-term approach. Building portfolios as a portion of a total percentage and buying fractional shares are great features for constructing a long-term investment, but not a short-term trade.
In fact, the difference between trading and investing is so great that I use several apps just to take advantage of their strengths and weaknesses. There is no one investment app that's perfect for both long-term investing and short-term trading.
Choosing a security type depends heavily on whether you're trading or investing.
In my personal retirement focused Roth IRA account, I have a long-term investing approach. Because of the investing approach, I have built that portfolio to be resilient to the types of risk involved in longer-term investments. I've also chosen a brokerage suitable for these needs.
I choose to use mostly ETFs and Mutual Funds in my long-term Roth IRA. Because of the tax-advantaged nature of a Roth IRA, I don't have to worry about incurring capital gains taxes like I might with a shorter term brokerage account with, say, Robinhood.
When I dabble with trading securities I certainly don't use mutual funds! These securities are priced at the end of the day and their net asset value always equals the public offer price. That is to say, there's no real way to trade them effectively for large profits in the short term. They would make awful trading vehicles and might even incur extra fees if bought and sold within short windows of time.
For trading, I would stick with ETFs, stocks, futures, Forex, and other short-term items. Trading "penny stocks" is a popular method of experimenting, and even becoming wildly successful, with short-term trading strategies.
If you're interested in trading, see my video about how to find penny stocks for Robinhood.
Which Apps are Good For Trading and Investing?
If you've been following, you should see a difference between trading and investing. Neither one is superior - that's not the purpose of this article. Instead, you should be starting to think about how to approach both investing and trading with smart tactics.
Which apps will you use for each method? WIll you use a brokerage? What are your goals with your money? How long can you leave your money alone before you may need it? How much time, research, and attention are you willing to put into your efforts? These are the important questions that will help you choose whether you're trading or investing.
Simply based on their fee structures, setup, layout, and features some apps are inherently more helpful for each type of buying and selling. Whether you're investing or trading there's definitely an app for you. Let me sort them, in no particular order, into investing apps, and trading apps.
Is Investing Better Than Trading?
I wanted to quickly touch on the idea that one concept or the other is "better". Just to clear the air, there is no superiority of one above the other. In fact, fundamentally, they're the same thing! The only reason I'm hoping to help you learn the difference is so that you don't make mistakes with your own money.
Buying and selling securities is differentiated by many things but most importantly for this discussion by the time horizon of your buying and selling. The strategies, methods, securities, and so many other factors must depend on how long you plan to hold your position! Even the app that you use must depend on what your intended purpose is for your money.
Neither investing nor trading is fundamentally superior to the other. But you don't use a square peg for a round hole, do you?