This article aims to define the terms “trading” and “investing” and then explaining the differences between two.
Trading is one of the many types of business activities carried out to earn profits. Trading is one of the simplest trading activity which involves buying and selling of finished goods. First important concept is that trading involves purchase and sale of good and not involves sale of services. Second concept is that trading involves just purchase and sale of good, it involves no further processing on the goods bought. Business model is that finished goods are bought at lower price and then sold at higher price, difference being the profit for the trader. It is not necessary that each sale will result in profit; it may also incur loss if prices fall in the time period between purchase and sale of goods.
Investing is a type of business activity that involves fixed amount of investment that provides variable or fixed returns on the value of investment. Return can be in the form of rent, interest or dividends depending upon the type of investment. In case of investments capital invested remains safe and returns are prone to risk of variation depending upon economic circumstances. Normally risk and return are directly related to each other therefore investments with higher risk provide higher returns than those having lower risk.
Difference between trading and investing
Trading and investing are different in many aspects. The major points of difference between trading and investing are as follows:
In trading, most of the investment is in working capital whereas in investing most of the investment is in fixed capital. In trading whole capital invested in goods bought for resale and is prone to risk of variation because prices of good may decrease by the time it are to be sold whereas in investing there is less risk in fixed capital and only return on it is prone to higher risk.
Time period between buying and selling goods is known as trading cycle. A trading cycle is normally short and there are frequent reinvestment or trading cycles in an accounting period. All the investment in trading cycle is recovered when trading goods are sold and need to be reinvested. In investing, capital can be invested for long term for more than one accounting periods to earn periodic returns. There is no need to replace the investment until there is need to withdraw the investment for another use.
Trading has more risk and therefore can provide more returns in the form profits because all the capital invested in trading cycle increases or decreases in value. Investing is normally less risky and provides lower returns. In investing, amount of capital invested does not change in value except for inflation and only return on it may vary if it provides variable rate of return.
In trading, more active participation of the investor is required to manage the purchases and sales whereas in investing, there is no need for active participation after the investment has been made. Management ability of the trader may affect its profits because better negotiation in buying and better pricing decisions in selling can improve profits. In investing, no management is needed after the investment has been made.
Trading involves purchase and sale of goods to earn profits whereas investing provides fixed or variable returns on the capital invested. Trading also involves more active management and higher risk and returns than investing. In trading investment can be changed after each trading cycle whereas in investing fixed amount of capital is normally invested for longer time period.