Trading or Investing: Which is Right for You?
The Difference between Trading and Investing
Trading, commonly known as “day trading”, is buying and selling stocks within hours, minutes, or even seconds. Positions are typically opened and closed within the day and it is unfavorable to hold over night. Investing is basically the opposite. Investing is holding a position for at least a few days or for several years. Investing can be classified as long term (1 year or longer) or short term (less than a year), typically for tax purposes. Short-term capital gains are taxed higher than long-term capital gains.
Initial Capital Necessary
According to Day Trade Online, the average amount of capital necessary to start trading is $5,000. If trading becomes a full-time career, the amount needed is $50,000. There is no exact amount of capital needed to begin investing, as long as there is enough money to cover brokerage fees. Although, the more money invested means more profit possible during percentage gains and more money lost during percentage losses.
Day traders must be constantly involved in the market and accumulate small gains that add up. Day traders can be part-time, or full-time, thus trading everyday as a way of making a living. On the other hand, investors can be as passive or active as they like. Some investors view their portfolio several times a day, while others may buy shares and check on them a few times a year. Often times, more passive investors will simply buy mutual funds rather than a whole portfolio of individual stocks.
As an investor, it can be disheartening watching portfolio values bounce up and down over the course of several months or years. Day traders focus their energy on smaller, more intense intervals which can lead to explosive gains or downward spirals. Being a day trader requires little patience as far as holding positions. Investors must have the tenacity to ride the seas of time, while day traders must swim with the Wall Street sharks.
Any market expert or analyst will admit that investing requires a great deal of research. Evaluations must be made on a stock’s performance, along with the underlying company itself. A financial background is beneficial in understanding financial news and reports. The ability to comprehend financial ratios, charts, statistics and other related market data is critical in investing. Day trading, however, requires little financial knowledge or background. It is still very difficult nonetheless and requires a certain type of person to be successful. The day trader doesn’t research a company’s financials or even care what a company does. They don’t have to understand P/E ratios or look at the 52-week price range. The next section provides a checklist of what the day trader and the investor look for when selecting a stock.
Investor and Day Trader Stock Evaluation Criteria
The fundamental investor (assumed to be a value investor) looks at the following:
- Low P/E Ratio
- Price near 52-week low
- Strong Financials
- Earnings Growth
- Analyst Ratings
- Dividend Yield
- Economic Forecast
- Industry Analysis/Rival Performance
The day trader looks at other information such as:
- Bid Price
- Bid Size
- Ask Price
- Ask Size
- Average/Daily Volume
- Low Volatility*
- Low Price per Share
- Stocks with low media coverage
*Most day traders look for steady movement and small price fluctuation where they can make several small gains by exploiting the bid-ask spread. Momentum and swing traders are the exception; they look for highly volatile stocks that make large, quick gains.
Profit and Loss Time Frame
Investors have a prolonged exposure to the market, which day traders do not have. This extra time allows for stocks to rise and fall, with the typical average stock return of 12 to 15 percent per year. Although recent markets have fallen severely below this average, a recovery is underway. The risk day traders face lies within the large blocks of shares they buy and sell. If a trader is holding thousands of shares and there is a price drop, this can be a devastating loss of trading capital. Even though the trader doesn’t have the long time exposure to the market, the slightest change in price can equal very big risk. The opposite is also true of profits. It is possible for the day trader to make several thousand dollars within one morning of trading, which might take the average investor several months.
The Costs of Trading and Investing over Time
One unfavorable component of investing and day trading alike is the trading fees for buying and selling stocks. In investing, the fees make up a minor fraction of the cost of creating a diversified portfolio. Buying a dozen stocks may only cost a little more than $100 with an online broker. Selling fees are infrequent and maybe even nonexistent since stocks are held for long periods of time. There are usually no fees for inactivity, as well. Day trading, as we know by this point, consists of multiple buy and sell orders each and every day. This means there are multiple buy and sell fees to pay. Most day traders average between 8 and 36 transactions per day. If they trade every day and there are approximately 250 trading days per year, that would be an average of 2,000 to 9,000 trades per year. If they pay the typical $9.99 per trade, they would be spending anywhere from $20,000 to $90,000 per year in transaction fees alone.