The Difference Between Trading and Investing

Is Stock Trading Little More than Gambling?

The Difference Between Trading and Investing
April 29, 2014

It's easy to get a wrong impression of Wall Street and the stock market, especially given the standard movie portrayal – the stereotype of the high-rolling, risk-taking trader profiting by fleecing well-meaning investors. As with most embellishments, there may be grains of truth underneath, yet the stereotypes are still misleading. Let's look at general traits of investors and traders to find out why.

  • Investors – Investors look at the longer-term picture. They build wealth gradually through a buy-and-hold philosophy – buying what they believe are undervalued stocks and stocks of companies with solid financial fundamentals, then holding them for years. Investors are interested in the long-term health of the company and view the stocks as ownership positions.

    Investors ride out variations in the stock market, rebalance their portfolio periodically to better align with changing life goals and to diversify risks, eventually shifting to more conservative investments for retirement income.

  • Traders – Traders are interested in the short-term view and look at stocks as a means to short-term profits. They are generally not interested in the long-term health of the underlying company or even what the company does. They are interested only in the context of being able to predict the price and its short-term direction.

    Traders are able to analyze trends and patterns and use insights into various stocks to buy and sell for profits in short timeframes. They may be position and swing traders who may hold a stock for no more than a few months, day traders who get in and out of the market daily with no overnight holdings, or scalp/flash traders who only hold stocks for minutes, or even seconds.

    Traders adjust their risks by using mechanisms like stop-loss orders (cutting losses if a stock falls to a certain price) and short selling (selling borrowed stocks, assuming the price will fall when it is time to replace them).

Ultimately, the goal of both investors and traders are the same – to build wealth. They just differ on the method.

So how does this relate to gambling? On either end of the spectrum, there is little overlap. A true investor has little in common with the gambler who plays slot machines and other pure games of chance.

However, the day trader and the professional poker player arguably have as many similarities as differences. Practitioners who don't do their homework and research, and don't have the skill and temperament to compete in the field ultimately fail, and they chalk their poor results up to bad luck. For those people, both probably consider what they do gambling at root.

Those who do their homework may see themselves as superior assessors of risk and reward and of the reactions of their fellow traders/poker players. They understand tendencies and statistics, follow principles, and can identify opportunities.

There are arguably some differences between trading and gambling. For one, the odds are more favorable in the stock market, as there is no “house” with a built-in mathematical advantage — although with the recent accusations of rigging of high frequency trading, that point is debatable.

Also, companies generally put money from investments to use in capital investment, such as developing new products, and services, while gambling money only establishes winners and losers in a zero-sum game. Those who are employed by casinos, and those who profit from lottery proceeds (such as schools in some states) may disagree.

So is stock trading little more than gambling? We think there is one point of 100% agreement – if you don't do your research and homework in either pursuit, then day trading and gambling are pretty much the same thing, resulting in consistent losses.

For people with proper skills and work ethic, a reasonable argument can be made both for and against the resemblance between successful stock trading and successful gambling. Traders are often insulted to be considered as gamblers. One wonders if gamblers are insulted to be considered as traders.

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