Risk and Reward of Investing vs. Trading

Disclaimer: Please note that all content and information in this blog are for educational and informational purposes only and should not be taken as professional investment advice.

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As long-term investors, we typically only need to know when to buy the stock. But as traders, we need to know when to buy and when to sell. Simply put, trading usually requires twice as much effort as investing. In that sense, we are taking on twice the risk when trading (risk from buying and risk from selling), and as such, we should expect to get compensated with at least twice the returns of investing.

While the above is a heavily simplified comparison between trading and investing, the key message is that trading often entails higher risk than investing. As rational investors, we expect to get rewarded financially more for the higher risk we take on when trading. However, in reality, this might not always be the case, as timing the market (i.e., trading in the short term to profit) has often been proven to be less profitable than time in the market (i.e., investing for the long term).

"Time in the market beats timing the market.” — Kenneth Fisher

The greater effort and risk we put into any endeavour we undertake (whether in our work, hobbies, relationships or investments), the higher return or reward we expect to yield from it. If the returns reaped from trading isn't in proportion to the amount of effort we put in and the risk we take, we would be better-off sticking with investing.

My view

Personally, I would rather invest for the long-term than do active short-term trading. While trading could technically be done passively, such as by selling put options to earn "passive" income, or setting up take-profit and stop-loss points in our trades, it still requires some active management from the trader.

Investing on the other hand, usually only requires more time and some "active management" at the start. Once we are invested, we can afford to take a somewhat more passive approach to our investments, and more so if we are invested in ETFs tracking the market index instead of holding onto individual stocks that would require more active monitoring.

For example, if one has a full-time job and has little time or passion for trading, then it is advisable to steer clear of trading because even if it does turn out to be profitable (oftentimes by pure chance), the time and effort spent on it may not be worthwhile, especially if you already have a full-time job.

Avoid turning a trade into a gamble

However, if one has the time and is passionate about trading, then one could trade for some "passive" income. But it is important to know the risks involved in trading and how to avoid them. Trading without the proper skill or knowledge is like driving a car without a license. You may be able to handle it for a while but once things spiral out of control, things can quickly turn ugly, especially if you are trading with money you cannot afford to lose or are using excessive leverage. Trading without the proper knowledge and skill where one buys and sells based purely on fear and greed turns trading into gambling and the stock market into a casino.

While making some small occasional trades (or "bets") purely for fun or entertainment is generally harmless, individuals could in the process, be unawaredly blinded by greed or overcome by fear in their trades, which could result in significant financial losses, which may have adverse effects on one's physical and mental health over time. As such, if you do not have the time or simply lack the proper knowledge and skill in trading, it is best to steer clear of it.

Similarly, investing without the proper knowledge could prove to be detrimental as well, albeit less severe than trading as long as you invest with money you can afford to lose and do not invest with leverage. Without the proper knowledge in investing, investing in ETFs would be the best way forward, since the chances of outperforming the market is proven to be very low, even if you do have the proper knowledge and expertise when it comes to investing.

“In the short run, the market is a voting machine. In the long run, it is a weighing machine.” 

— Benjamin Graham

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Disclaimer:

The content and information provided on this blog is solely for educational and informational purposes, and should not be construed as financial advice. The accuracy or completeness of the content and information provided in the blog cannot be guaranteed. Before making any investment decisions, it is important for readers to research and carry out independent verification of the information provided, or consult with a qualified financial professional. No warranty and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of actions taken based on the ideas or information found in this blog.

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