There is a common misconception that investing and day trading are the same thing. Yes, they both involve the stock market, but they are two totally different things.
We are going to go through what are the similarities, what are the differences and the pros and cons on investing vs. day trading. We will also see some examples of the different approaches. First let’s start with a brief description of both.
Investing
Investing is when you put your capital in an asset that is going to provide you with a return in the future. You can invest in businesses, stocks, real estate, mutual funds, REITs and more. Investing is usually with a long-term horizon. When you invest in something it usually means that you are going to expect a return after years or even decades.
Day Trading
Day trading is when you buy and sell a stock within a very short time interval. Sometimes within an hour, sometimes within a couple of hours, but always during a single day hence the term day trading. With day trading your time horizon is short, usually just a day.
Similarities
Now that we know what both of those mean let’s check out some similar features between them.
Both Are In The Stock Market
This is also one of the main reasons that people think that they are the same thing. Essentially investing in stocks and day trading stocks are both done in the stock market. They both involve the same companies and they both use similar terminology and Metrics.
Both Are Involved With The Same News
Both investors and day traders generally speaking follow the same news regarding the stock market and the economy. They both read financial news, earnings reports or balance sheets/income statements.
Differences
Time Horizon
This is the most obvious difference between the two strategies. Investors are buying into a given stock for years or even decades to come. Day traders on the other hand are buying something for the opening 2 hours of the market for example.
Valuation
Day traders and investors are using a total different approach to valuing companies. Day traders use technical analysis. A technical analysis chart looks like this:
Technical Analysis Chart
Day traders use charts like this to determine the price move of the stock for the next couple of hours/days. They also use things like sentiments and earnings reports, but technical analysis charts are widely used in the space.
Investors on the other hand use something called fundamental analysis. This in short means finding the fair value of a given business and seeing if it is a good value for the current price. Investors rely more on balance sheets, income statements and long-term macro and microeconomic trends.
Time Involvement
Here is another difference – day traders usually spend more time per day in the stock market. They need to follow charts, stock movements and news much more in order to make profitable trades. Investors on the other hand can leave their positions for months without touching them.
To sum it up investing is much more passive while trading is much more active. You still need to put in some time in both cases, but to be a day trader you will need to be in front of the screen much more often and be much more involved.
Capital Needed
In order to be a day trader the legal requirement in the US is a minimum of $25,000. For investing you can start with as little as a dollar. Of course in both cases you need a good sum of money in order to see a decent return. But if you want to start investing you can do that with as much or as little as you wish.
Taxation
Generally speaking day trading is much more complicated tax-wise. As you are placing a lot of trades every day you are going to get taxed for every piece of profit that you make. Now, taxation is different in every country and things can be slightly different at some places, but generally speaking long-term investing is much more favorable tax-wise.
For example in the US the short-term capital gains tax is 10%-37% while the long-term capital gains are between 0% and 20%. The difference comes from the fact that the short term capital gains (day trading is in this bracket) is taxed as a normal income. Long-term investing on the other hand is taxed differently at a lower tier.
For your country you can always check the taxation with a quick online research.
Which One is Better?
I know there are a lot of people asking that and unfortunately there is no such thing as a right answer. You will get the same answer for tomatoes vs cucumbers, tennis vs basketball or Spain vs Italy.
They are just different things and neither of them is better than the other. There are people that like cucumbers more and others that like tomatoes more, it’s a matter of preference and neither of them is wrong.
What I can try to do though is show you the pros and cons of both and you can try and figure out which one is more suited for you. Now, because the pros for the one will be the cons for the other I will just list the pros for each of them.
Pros for Investing
1. More Passive
As we have talked earlier in the article investing is generally more passive. That is because once you open a given position you don’t need to do much with it in the future. Most of the work in investing comes from evaluating companies. Once you do that and have your portfolio up and running you just need to take care of it.
It is a lot like having a house. Most of the work is done when building the house and designing the whole construction. Once that is done and you have a well-built house you just need to take good care of it and do some maintenance every now and again.
2. Less risk
Ok, this one can be true but it can also be false depending on the style of investing. Generally speaking if you invest in ETFs the level of risk is much smaller than trading stocks. Even if you invest in solid large-cap Dividend Stocks the risk is much smaller than when you are day-trading.
3. Less Stress
As you already know the most work you need to do when investing is to build your portfolio. For anyone that is interested here is my guide on How To Build a Stock Portfolio For Beginners. When you do that you can leave it alone and just check it every now and again. After a couple of years and after you go through a recession or two you stop paying much attention to the daily movement of the stock market.
With day trading on the other hand you need to be involved in the market every day that you want to make profit. You need to watch news, read charts, follow graphs etc.
You also need to deal with your emotions a lot and manage your stress, because day trading is a very psychological thing. You need to deal with greed and fear on a daily basis, which is not very easy.
With long-term investing you also need to deal with greed, fear and all that, but much less often and it is much easier to deal with, because you don’t need to make decisions based on it every day/hour.
4. Less Capital Required
As you now know the minimum requirement for day-trading in the US is $25,000. Also generally speaking in most parts of the world you will have troubles opening an account for day trading with a smaller sum than that.
Of course you can find a way around it by just doing one trade a day or by swing trading, but if you want to be day trading properly you need more money to start than investing.
On the other hand if you want to start investing you can do that nowadays with as little as a dollar. For anyone interested on how to start with little money here is an article I made on How Much Money Do You Need To Start Investing.
5. Easier to Start
To start investing is not that hard at all, especially if you are going to be investing in index ETFs. For anyone interested can check out on How to Start in the Stock Market. Generally speaking you need to find a broker, to have a debit card and to learn a couple of things about stocks and ETFs.
Of course there are a ton of things to learn about investing and the economy if you want to be more serious about it, but learning the very basics and how to pick an ETF is not that hard at all. In fact you can learn everything about the very basics of investing from my couple of articles on this website, even if you are a total beginner.
Now of course if you want be a serious investor or if you are managing a lot of money things are more complicated than just picking a couple of stocks and ETFs. But everyday people like you and me can still enjoy very good returns by just choosing a couple of stocks and ETFs in a simple buy and hold strategy.
A lot of people get scared of the stock market because of all the charts and graphs they see on places like Bloomberg TV. What they don’t understand is that most of those news are actually targeted at day traders, swing traders and big hedge fund managers.
Most of the people don’t really care about what the price of iron is at a specific hour of the day or how is the japanese yen trading against the US dollar in the last 7 hours. However, day traders do care and that is why they are showing that information.
Here is also where the main difference comes in terms of starting out. In order to be successful in day trading you need to learn much more things, follow much more things and have a broader understanding of the economy as a whole.
You can invest in an S&P500 index fund and expect to turn a profit within a couple of years even if you don’t know what is interest rate. But you can’t day-trade gold against the euro and expect to be profitable if you don’t know what you are doing. Hope you get my point.
Also there is much more terminology and psychology involved in day trading. It is also a normal thing if you are losing money in day trading for years before you understand how to make money.
Pros of Day Trading
1. Higher Profit Ceiling
We have seen so far that day trading is riskier and more time consuming, but that comes with a reward. The reward is that day trading can be generally more profitable then investing. As everything higher risk leads to higher reward.
Also because you are spending much more hours in front of the screen you have much more opportunities to find profitable trades. With high volatile stocks and options trading you can see returns of thousands of percent in a single day.
But please be careful because you can also see all your money evaporate within a single trade. As I said with the higher risk comes higher reward, but also with the higher reward comes a higher risk. Things like options trading require a lot of knowledge and education before being able to use them properly.
2. Can Turn Into a Full-Time Income
It takes a lot of time and dedication, but if that is what you want to do and you are good at it you can actually make a full-time income trading stocks/forex/commodities/whatever. There are people who even make a lot of money doing that and if that is something you want to do you can too.
As I am not that into day trading I cannot help you out on how to do that. Still there are plenty of sources on the internet where you can learn more about day trading if that is something you want to do.
That being said don’t think that investing cannot turn into full-time income. Of course it can, but that usually happens much more down the line and is not exactly a job, but more of a residual income.
3. Have More Tools At Your Disposal
While investors generally go long on positions (long is when you buy a stock) stock traders use a lot of tools and techniques. They use short positions, options, margin trading and other things to benefit from the market movements.
Going short for example means that you make money when the stock is going down. It also means that you are losing money if the given stock is going up.
Using options is kind of like betting on where the stock price is going to be at a given time. It can be for the next day, for the next week, month etc. Using margin is borrowing money against your portfolio to boost your returns.
All of those tools can amplify your returns, hence why you have a much higher ceiling. But that also means that your potential losses are much bigger. First you are paying interest on all of those and second the market is volatile and just one movement against your position can lose you a lot of money.
Generally speaking those tools are only used by very experienced traders and big hedge fund managers, which know what they are doing. The levels of risk is also why it is hard to get accepted by your broker for those types of tools.
4. Can Use It To Supplement Your Income
Swing trading or day trading can be actually a decent thing to know, even if you have no intention of doing it full time. A couple of swing trades a month can bring you some extra money that you can put into your portfolio or help you pay for bills.
Just because you are a long-term investor doesn’t mean that you cannot place some trades every now and again and vice versa. In fact most of the day traders also have a long-term portfolio, where they invest their gains. Also a lot of the more advanced investors also place some swing trades every now and again to boost their portfolio.
Examples
Ok, we have now checked the main similarities, the main differences and the pros and therefore cons of both styles. Now let’s check out some examples of those different styles. Naturally the difference is in the time period of the positions.
There are long-term investors that hold positions for many many years. There are also investors that hold positions for a couple of years. There are also investors that hold positions for a couple of months to a year. And there are day traders and swing traders that hold ones for a couple of hours to a couple of months.
let’s Check Out Some Examples
Warren Buffett – Long-Term Investor
This is the best example of a long-term investor. He’s got positions that he has held since more than 50 years ago. He has been consistently in the top 3 of the richest people in the world during this century thanks to his approach to investing.
His compound returns over the years are over 20% and his history of the stock market begins way back in the 50s. Do you remember the example with the house? How once you build your house you only need to maintain it every now and again?
Well he has not only built a house, but a whole empire. All of his positions and companies are now bringing in billions of dividends every year and all he needs to to is find where to put the money.
Peter Lynch – Medium-Term Investor
If you don’t know who Peter Lynch is he is the investor with the one of the best compound annual returns in history with over 29% every year. He was operating the Magellan Fund for Fidelity. Once he started the fund was worth $18mln. and at his last year it was worth more than $14bln.!
His strategy was more of a medium-term investing as he has been moving out of positions every couple of years. His strong side was finding big economic trends and finding the companies that are going to be the most benefitted by it.
He was also researching companies very in-depth by going to meetings with the owners/board of directors etc. He was famous by finding the ”10-baggers”. That means companies that are going to provide returns of 10 times the invested capital.
If you are more interested about Peter Lynch he is also my favorite author for investing books, you can check some of them out in my Books section.
Ray Dalio – Mixed Investor/Swing Trader
For those of you that don’t know him Ray Dalio is running the biggest hedge fund in the world – Bridgwater Associates with assets under management of over $120bln. They operate an array of different funds depending on the risk profile, but the one with the best returns is providing over 16% annualised rate of return over the last 20 years.
Dalio’s biggest strength is his macroeconomic view and his risk management. All of his funds rarely have any down year and most of then are actually up during recessions. His style is very mixed.
He have thousands of different positions in a lot of different countries with a very different time horizon. Of course there are thousands of people working for him hence why they manage so many different positions.
To sum it up him and his team are using all kinds of different tactics to find the best place for their client’s money. They place short trades, have long-term positions in stocks and ETFs, have exposure to commodities, bonds, real estate etc.
Of course they can afford that because they have algorithms worth millions of dollars and a lot of highly educated people at their company.
Jim Cramer – Day/Swing Trader
Probably a lot of you know Jim Cramer from his show on CNBC, where he talks about different stocks and the market. Back in the days Cramer used to run a hedge fund named Cramer&Co. He ran that fund for 14 years up until 2001 and had an annual return of 24%.
He managed to make such a return by reading a lot of news every day and understanding the psychology of the people in the stock market. He used to wake up at 4am every morning, read all the news about the stock market and then start placing trades when the market opens. Him being a reporter has also helped him, because he has known everything around Wall Street.
Conclusion
That is going to be everything from me around investing vs day trading in the stock market. Hope you now have a better perception around all the differences between those styles. After all they are completely different kind of things, but in the same time have a lot of similarities.
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