Why do people trade?
There are many reasons why people or companies might trade.
The concept of trading is assumed to have been around for 100’s of thousands of years, ever since humans first realized they could exchange their goods or services to acquire others. This hasn’t changed today, as many trades still happen out of need or necessity.
If you were to travel abroad, for example, you would need to trade your U.S. dollars for the local currency. Otherwise, in a country that doesn’t accept dollars, you’d find it difficult to buy products or pay for services.
A company that manufactures smartphones would need to buy a range of materials including metal and plastic, so they could build the devices. To do so, the company would turn to the commodity market, where they could trade their money for materials.
What about financial traders?
When it comes to financial traders, there isn’t usually a need, but rather a desire to speculate.
In simple terms, they are interested in trying to turn a profit from the rising and falling prices of financial instruments. In other words, financial trading is seen as a form of investment.
Think of it like this. Imagine you were to take $1,000, put it in a drawer and forget about it for 5 years. How much would your money be worth? If you’re lucky, it’d still be worth the same, but it might be worth even less due to changes in inflation and the cost of living.
Now, say you took that $1,000 and invested it in financial instruments like company stock or forex. There’d be a higher possibility that, after 5 years, your money could be worth more than its initial $1,000 value. Of course, as with any investment, there is a risk its value could drop as well.
The difference between trading and investing
There is often confusion about the difference between trading and investing.
Simply put, it’s down to a matter of time. Investing usually describes the process of buying and keeping a financial instrument for a long period. A good example is a 401(k) plan. Offered by many employers, this type of defined contribution plan sees money invested long-term, to grow the amount for retirement.
In contrast, trading is normally used to describe attempts to profit from short-term market movements. The exact amount of time can vary, with some traders even placing hundreds of trades per day to benefit from small price fluctuations.