This article takes a look at the differences between cryptocurrency investing vs trading, which can be deceivingly similar at first glance.
There are several ways for anyone to generate wealth in the Cryptocurrency market. You can either be a:
Mining is a technical process that requires someone to have background knowledge and experience in setting up sophisticated computing software and equipment to mine new cryptocurrencies. Undoubtedly, the easiest way for the general public to make money in the cryptocurrency world is through investing or trading.
The terms ‘investing' and ‘trading' has often been used interchangeably in the cryptocurrency market. However, there are fundamental differences between both concepts that is vital for you to understand and align your financial goals with. This guide will be fully dedicated in exploring the various differences.
Warren Buffet Vs George Soros
Before delving into the specifics, let's take a look at two prominent giants that embodies of our subject matter; one is a prolific investor while the other is a legendary trader. Both have generated a massive amount of wealth in their lifetimes, but in different ways.
Warren Buffet is a renowned long-term investor with an effective style of value investing. Value Investing refers to the investing in under-priced investments or stocks that are trading at a discount to their intrinsic value.
In the world of finance, intrinsic value refers to the value of an asset (company, stock, currency etc.) that is calculated through fundamental analysis, which requires analyzing quantitative statements. The core elements of financial statements include a company's Balance Sheet, Cash Flow, Profit & Loss Statement.
Buffett has the ability to identify valuable companies and has bought, sold and invested in hundreds of companies over his lifetime. Among his notable investment holdings are household brand names such as Coca-Cola, Apple, American Express and The Washington Post. Buffett owns Berkshire Hathaway, a multinational conglomerate that is currently the third largest public company in the world with a value of close to $500 billion. Buffet’s value-investing philosophy has a long-term investment horizon since it takes time for the assets to appreciate in value fundamentally.
George Soros on the other hand, is a legendary trader who is known for his contrarian approach (going against the status quo) to trading. He once ‘broke the Bank of England’ by shorting (betting against) the sterling pound and making more than $1 Billion in just that trade alone! Not only that, Soros went out again and betted against Thailand and Malaysia’s currencies (Baht & Ringgit respectively) in 1997, which generated hundreds and millions of dollars in profit. However, it came at a cost; Soros was blamed for igniting the Asian Financial Crisis for his actions.
Soros also managed arguably the world’s most successful hedge fund (Quantum Fund), generating a mind-boggling 30% returns for investors over the period of 3 decades.
In order to understand the magnitude of Quantum Fund’s returns, an initial investment of $1,000 in 1970 would have grown to a whopping $4 million by the year 2000!
While Soros scours the market for short-term trades to exploit the status quo, Buffet unravels undervalued companies for the long-term. It is clear that Buffett and Soros are two individuals with different styles of wealth creation but they shared a commonality; they were highly successful in making tremendous amounts of money.
Investing Vs Trading: What's the Difference?
Let’s take a deeper look at the differences between investing and trading. There are a total of 5 key differences that include:
1. Investment Period
Investors are usually geared for the long-term and are not concerned with short-term price movements. In order words, an investor will bet on the long-term potential of a coin when investing in it, with the intention to sell it (and realize a profit) in a couple of years. The rationale behind this is that blockchain technology is extremely new and it could take a few years (or even decades) for an infant technology to disrupt traditional systems and gain mainstream adoption. It must be stated that the market cycles in the cryptocurrency market is much shorter as compared to the stock markets. This means that the cryptocurrency market experiences a bull market (upwards trend) and a bear market (downward trend) at a shorter period with a greater intensity. For instance, it can take years for a bull or bear trend in the stock market to last while it will take a much shorter time – usually within a year – for the cryptocurrency markets. (Read also: Why do people hate Bitcoin & Cryptocurrencies? Here’s 5 Common Misunderstandings)
Traders on the other hand, possess a short-term horizon with an emphasis on price movements. Traders are concerned with hourly and daily price movements of the cryptocurrency market, engaging in buying and selling of coins with the objective of short-term profits. The basic goal of traders is to buy a coin at a low price and sell it at a higher price in the next minute, hour, day or week. Volatility is a critical component that traders look out for when trading in the short-term horizon, since prices must have sufficient price movements for traders to be profitable. The extreme volatility of the cryptocurrency market makes it a highly profitable endeavor for traders. (See more: Guide to Market Capitalization: Everything You Need to Know About Market Cap)
There are different types of traders that include:
- Scalpers: Perhaps the most active form of trading, scalpers will buy and sell coins many times a day, with the objective of ‘scalping’ or making a small profit in each of the trades. The trades can be as short as seconds or even minutes! Scalpers rely on frequent and small gains to generate a cumulative chunk of profits by the end of the day. Scalpers will tend to make quite a large number of trades – dozens or hundreds – in a single day.
- Day Traders: As the name suggests, day traders execute trades within the day and would close out any positions at the end of the trading day. More often than not, day traders do not hold any overnight positions. Each trade could last minutes or hours, with constant monitoring of price movements to exploit intraday price anomalies.
- Momentum Traders: In momentum trading, trades are executed according to the strength of current price trends in the hopes that the ‘momentum’ will continue in the same direction (either upwards or downwards trend). Momentum traders aim to ‘ride the wave’ by executing short-term positions across a particular market direction; buying at a low price in an uptrend and then selling as soon as prices start to break the momentum or selling at a high price in a downtrend and buying back at a lower price. This requires a good understanding of market conditions and an acute sense of timing. The holding period for momentum trade can range from hours to weeks.
Traders can make money from both an upward-trending (bull) market or a downward-trending (bear) market. Making money in a bull market is easy; you buy a coin at a low price and sell it at a higher price to get a profit! In a bear market, traders can make money through the process of shorting (or sometimes referred to as ‘margin trading’). Shorting is the process of selling the coins at a high price by borrowing the coins from a third-party (usually from a cryptocurrency exchange) and buying the coins back at a low price from the open market. This way, traders will give back all the coins that they borrowed in the first place and acquire a profit from buying back at a low price!
- Swing Traders: Swing trading is a strategy that takes advantage of a coin’s short-term price swings, typically ranging between a day and a few weeks. Technical analysis is used to identify potential opportunities where a coin’s price would explosively move in a certain direction within a short time.
2. Trade Frequency
This refers to the frequency of executing trades. Trade frequency is directly linked with the investment period of an investment; the longer the time horizon for an investment, the lesser frequency of trades there will be. Investors usually have a low trade frequency, indicating that they will tend to hold on to a coin without selling until their long-term objective is met, which can span out a few years. Cryptocurrency investors would invest in a coin (or a number of coins) and store them in a cryptocurrency wallet for long-term safekeeping. (Read more: Coins, Tokens & Altcoins: What’s the Difference?)
Traders on the other hand, has a higher trade frequency. Traders would execute many trades since they’re in the constant pursuit of profiting from market opportunities. Though trading has gives a higher probability of generating more profits, it is a highly risky endeavor that requires active and constant monitoring of market conditions.
(See also: Guide on Identifying Scam Coins)
3. Risk Profile
Risk profile (or ‘risk appetite’) refers to the level of risk that one is comfortable with. It is important for everyone to understand the concept of risk in investing. Risk is directly related to the potential returns of a particular investment, as illustrated here:
It is no surprise that cryptocurrencies are the riskiest investment out there due to its extreme price fluctuations. The concept of risk is easy enough to understand, but it must be coupled with an understanding of potential rewards associated with the risks you're undertaking. This is called the risk-reward tradeoff, where a higher degree of risks would yield Understanding Cryptocurrencies: Game of Thrones Edition. If you don't like risk, you're called ‘risk-averse' but if you like risk, then you're a ‘risk-taker'.
Think about it for a second: The average stock market returns is 7-10% annually. You can literally make that in a single day in the Cryptocurrency world. However, you can also lose your capital by the same intensity. The extreme volatility of an investment makes it very risky!
If you're already in the Cryptocurrency market (by owning coins and tokens) then it is fair to assume that you're a risk-taker since cryptocurrencies are considered to be one of the most volatile and riskiest investment that you can make. However, within the Cryptocurrency landscape, individuals can still be categorized depending on the level of risks they consume. Cryptocurrency investors are more ‘risk-averse’ than traders, since they are more comfortable with leaving their investments alone and are not concerned with the daily price volatility. Over the long-term, the volatility of an asset smoothens out and therefore, it is less risky.
However, traders are ‘risk-takers’ since frequent trading incurs a much higher degree of risks. This is because the extreme volatility of short-term cryptocurrency prices can present traders the opportunity to make lots of money but could be equally disastrous if they are on the wrong side of the bet. Additionally, traders often engage in margin trading, which is a practice of borrowing funds from third parties to trade cryptocurrencies. Margin trading significantly increases the risks of trading since the traders have the ability to make more money (as compared to using their own funds) but also increases their potential losses.
4. Type of Analysis
Perhaps the most important distinction between cryptocurrency investors and traders is the type of analysis undertaken by both groups. Since investors take a long-term bet on the value of a coin, fundamentals is a core component in evaluating the viability and potential of a coin. It must be mentioned that fundamental analysis for cryptocurrency is vastly different than stocks since there are no publicly available financial statements for any cryptocurrency project. Several indicators of cryptocurrency fundamental evaluations include merchant adoption rates and general cryptocurrency usage rates.
Since traders are more concerned with predicting price direction and market positioning, technical analysis is the main weapon used by traders. Technical analysis is the forecast of future price by analysing historical price data by using various types of price indicators and charting tools. Price movements in the short-term are often erratic, thereby requiring traders to use technical analysis to time the market and profit from the volatility of prices.
5. Profit Methodology
Profit methodology refers to the way in which traders and investors aim to make money and generate wealth. For cryptocurrency investors, there are four main ways to generate profits from their investments.
- Price Appreciation is the most straight-forward way to earn a profit; it refers to the increase in cryptocurrency prices.
An example is buying Bitcoin at a price of $1,000 and waiting it to appreciate in price to $5,000 before selling it, giving you a profit of $4,000.
2. Dividends on the other hand, is a concept related to stocks where shareholders are entitled to receive cash generated from the company, relative to the amount of shares they own. In the cryptocurrency world, some projects offer dividends to coin holders from the revenue they generated. It is a form of profit-sharing to increase the incentive for investors to hold onto their coin for the long-term. Another form of ‘dividends’ that is unique to the cryptocurrency market is coin burns, which refer to the deliberate destruction of coins by the projects, in order to reduce the overall coin supply and enhance the value of the coin’s price. This is an interesting concept that is further explained in this article.
3. Hard Forks is a phenomenon where a coin splits up into two and investors who holds the original coin would be entitled to ‘free coins’ that are produced as a result of the split. An example is Bitcoin Cash (BCH), which is a project that diverted from Bitcoin (BTC). After the hard fork split, holders of BTC were automatically credited with BCH in their Bitcoin wallet. This can be also termed as ‘free coins’.
4. Airdrops are a novel way for some projects to distribute their coins for free to the general public for publicity and marketing purposes rather than fundamental economic reasons.
For traders, they are primarily concerned on the price movements of coins to time their entry and exit points. Therefore, price appreciation is the main objective for traders to make money. Since traders are short-term oriented and are active in the market, they would jump on every opportunity to make money, especially in cases of hard forks and airdrops just to get free coins and sell them immediately on an exchange to realize the profits.
(See more: Crypto ICO vs. Stock IPO: What’s the Difference?)
All in All
There are fundamental differences between investing and trading in the cryptocurrency world. Understanding these differences is key to figuring out which type of category you belong to, and what you should consider when dealing with your coins. The cryptocurrency market is still in its infancy stages and is in a constant state of evolution. It would be wise for you to only invest money that you’re prepared to lose.
(You might also be interested in Will A Crash in Bitcoin’s Price Lead to Its Demise?)
Beneficial Resources To Get You Started
If you're starting your journey into the complex world of cryptocurrencies, here's a list of useful resources and guides that will get you on your way:
Trading & Exchange
- Crypto Guide 101: Choosing The Best Cryptocurrency Exchange
- Guide to Bittrex Exchange: How to Trade on Bittrex
- Guide to Binance Exchange: How to Open Binance Account and What You Should Know
- Guide to Etherdelta Exchange: How to Trade on Etherdelta
- Guide To Cryptocurrency Trading Basics: Introduction to Crypto Technical Analysis
- Cryptocurrency Trading: Understanding Cryptocurrency Trading Pairs & How it Works
- Crypto Trading Guide: 4 Common Pitfalls Every Crypto Trader Will Experience
- Guide to Cryptocurrency Liquidity: How to Measure Liquidity & Trade Well
- Guide to Cryptocurrency Wallets: Why Do You Need Wallets?
- Guide to Cryptocurrency Wallets: Opening a Bitcoin Wallet
- Guide to Cryptocurrency Wallets: Opening a MyEtherWallet (MEW)
Get our exclusive e-book which will guide you on the step-by-step process to get started with making money via Cryptocurrency investments!
You can also join our Facebook group at Master The Crypto: Advanced Cryptocurrency Knowledge to ask any questions regarding cryptos!