Long-term investing and day trading have similar goals but take different approaches. Both want to make money in the stock market – they’re just on opposite ends of the risk/reward spectrum.
Imagine two people at the beach. One person is surfing the massive breakers – a thrilling, dangerous, intense experience. Another person is just chilling on the beach, drink in hand, watching the tide roll in. Same sand, same sun, same ocean. Both people are having a great day at the beach – but their experiences are very different.
So, if you plan to risk real money in the stock market, you first need to decide which strategy you will use. Are you an investor lying back with a drink in your hand? Or, are you a day trader catching waves and riding the adrenaline?
Answering that question requires you to understand some things about the market and yourself. This article will break down the concepts of investing and day trading, analyze the differences, and offer some recommendations.
What Is Investing and Day Trading
Before choosing a strategy, we need to understand some basic concepts. Let’s take a look at investing and day trading in more detail.
Investing is a long-term wealth protection and growth strategy, usually part of a retirement plan. In practice, this means using capital to purchase stock or mutual fund shares, then waiting years or decades for those shares to grow in value.
For example, consider a person with a full-time job and a family. He doesn’t have much time to spend on his investments and doesn’t want to take a big risk with his hard-earned money.
His solution is to invest in an exchange-traded fund (ETF) that tracks the S&P 500, which historically returns 10% per year, on average. He sells the shares upon retirement.
Day trading is a short-term strategy with high risk and high reward. You try to profit by buying and selling stocks based on small market fluctuations. In practice, you are betting that stock prices will shift in your favor on any given day.
For example, consider a single person with a high salary. She has disposable income to open an online brokerage account.
After some research and analysis, she identifies a stock she expects will rise following an earnings report. She buys shares before the report and sells them later that day after the announcement.
Main Differences Between Investing and Trading
Let’s look at some of the key differences between investing and day trading. And remember, we are looking at opposite ends of a spectrum. In reality, traders can exist anywhere between these two extremes – and usually do.
|Asset hold time||Years or decades||Days or weeks at most – the longer the hold, the greater the risk|
|Capital requirements||Any amount||High – $25,000 minimum for making more than 4 trades per week|
|Diversification||High – reduces risk||Low – must bet big on individual stocks|
|Buy & sell activity||Monthly or yearly – an investor might buy at regular intervals, and sell only upon retirement||Daily – sometimes multiple trades per day|
|Commission and fees||Low – buys monthly at most and rarely sells||High – pays a commission on every daily buy and sell|
|Volatility exposure||Low – unaffected by short-term market fluctuations||High – sudden fluctuations could be disastrous|
|Analysis type||Fundamental – investors look for opportunities based on company fundamentals||Technical – traders look for opportunities based on technical factors|
|Asset type||Growth – investors seek stocks that will grow steadily over time||Volatile – traders seek out stocks with wild price swings|
|Withdraw funds||Rarely – the funds are only needed upon retirement||Regularly – funds might be needed for living expenses|
Looking at Their Benefits and Drawbacks
Every strategy has strengths and weaknesses. The important thing is to choose the strategy that best aligns with your goals. Let’s take a closer look at the benefits and drawbacks of investing and day trading.
- Market volatility protection: Long timelines and diverse portfolios protect against short-term fluctuations in stock prices.
- Minimal time commitment: Once you invest, you don’t have to do anything else. Just sit back and watch your money compound and grow over time. Check your tracked portfolios less frequently.
- Limited emotional decisions: If you know you’re in for the long haul, you are less likely to make short-sighted, emotional trades.
- Extended timelines: While also a benefit, the long timeframes required for investment can dissuade some who want quicker returns.
- Trader envy: It can be challenging to watch day traders make 1000% returns with quick trades while you wait seven years to double your money.
- Big win potential: The main benefit of being a day trader is the potential for quick, huge returns. While an investor makes 10% per year, the trader could make 10% daily.
- Work from home: Thanks to information technology, a day trader can work from anywhere on earth with nothing but a computer and an internet connection.
- Significant risk: Day trading avoids all sound investment advice. Large amounts of capital are invested in single stocks while trying to predict an unpredictable market. Most day traders lose money.
- Full-time job: When done correctly, day trading requires as much time commitment (or more) as any other job. It’s not a quick and easy way to get rich – or a way to avoid hard work.
When is Investing or Trading a Good Option?
Neither trading nor investing is inherently better or worse. The value of each strategy depends on the situation, personality, and goals of the person involved.
Questions to Ask Yourself
- What is my tolerance for risk?
- Can I afford to lose all the money I use to trade – financially and emotionally?
- How much time can I commit to researching and analyzing stocks?
- Do I have the discipline to stick to a trading plan?
- How close am I to retirement?
- What kind of profits do I want to gain?
Answering these questions will help you decide which strategy is most suitable for you.
You should invest if…
- You have a low tolerance for risk
- You can’t afford to lose your investment
- You have a career that you love
- You don’t have significant time to analyze stocks
- You want to protect and grow your savings
- You are content with modest profits
You should day trade if…
- You have a high tolerance for risk
- You have extra capital to gamble or lose
- You want to be your own boss
- You have strong market knowledge
- You are not nearing retirement
- You want big profits
Our Opinion: Investing Is the Better Option for 90% of People
For most people, investing is the strategy they should choose – at least in the beginning. First, set up a safe, diversified, long-term investment plan. As you learn more about how the stock market works, you can consider riskier trades with capital you can afford to lose.
No rule says you must choose one strategy or the other. The reality is that most people involved in the market use a combination strategy. Parts of their portfolio are composed of long-term positions, and other parts are reserved for short-term trades. The key is to understand the difference between both and trade wisely.
We hope you now have a better understanding of how investing and day trading are different and which approach might be best for you. If you are interested in more great content about personal finance, stay tuned to the Stock Market Eye blog.