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Some of you might have read the title and got confused; there is a misconception that trading and investing are synonymous. However, this couldn’t be further from the truth as there is a huge difference between the two.
The rise of commission-free brokers in the past couple of years has made the stock market more accessible to the Average Joe. A person who makes just 10 trades in a year can save between $50 and $100 annually. However, the flip side of the coin is that having zero commission encourages trading over investing. I’ve seen a huge surge in self-proclaimed “traders” amongst younger millennials and Gen-Z because of that exact reason!
What’s the difference between trading and investing?
The short answer is this: the length of time in which you plan on holding the stock determines whether you’re a trader or an investor.
Now, there’s no set definition of what these timeframes are, but here is an approximate guideline:
The most common is day traders which, you guessed it, sell the stock the same day they buy it. There are also scalpers which take it to the extreme by buying and selling within minutes, even to just make a cent or two per share! These types of traders focus on purely technical indicators (ie. stock charts).
There are also position / swing traders which look at short term and medium term trends. They use a mixture of technical and fundamental (ie. revenue, earnings, profit margins, etc.) indicators. These people may hold stocks anywhere from two days to two months, or sometimes even longer!
Traditional buy-and-hold investors are Warren Buffett style investors; buy shares in a great company that you would own until you die! They won’t sell so long as the company remains a good one. Many people also take a buy-and-hold approach with index funds and other ETFs.
The active investors are the ones that closely resemble position traders, however, their mindset is a little more long-term. They rebalance their investments often and are always seeking a new opportunity. They might have core holdings that they’ve kept for years, but they also have many stocks they’ll keep for less than a year for various reasons.
The reasons you should invest instead of trade:
It takes up time that can be used for better things.
Trading is the antithesis of passive income. Even with all the automation in today’s day and age, it still requires a lot of human oversight. That oversight requires skill and expertise, which can only be obtained by educating yourself and practicing. That, in turn, requires a significant amount of time.
Is it worth that amount of time? Probably not. You can pick up any other hobby or skill with that spare time. And, the money you would’ve used to trade will now be invested, with the opportunity to make money without effort on your part! Win-win!
The market is tough to beat.
The index used as a benchmark in the U.S. is the S&P 500, which is the 500 largest companies ranked by market cap. It is VERY difficult to outperform this index on a long term basis.
This statement holds true even for the “professionals” in finance. It is actually something Standard & Poors keeps track of! Only ~18% of actively managed funds outperformed the S&P 500 over the past five years, as of their latest report. The people who invested in the other 82% of funds are paying fees to the fund managers in vain!
Long story short, a lot of these fancy strategies may work short-term, but underperform in the long run.
You need a LOT of money and leverage to trade successfully.
Note that the key word in the above heading is “successfully.” Technically you can trade with $1000 or even $100. Day trading is a regulatory nightmare if you have a small account though. You are limited to three-day trades in five business days, as you do not meet the requirements of a Pattern Day Trader (minimum $25000 in a margin account, among other things).
Now, even if we neglect the above, let’s say you are a trader with a $2000 balance. If you have godlike skills, grind every trading day, and make an extraordinary 50% return in a year, you’ll only have earned $1000 from your labor. You would’ve been better off getting a part-time job; it would’ve earned you that $1000 in less time!
If you had more capital, say $100,000, you’d need just a 1% win to make that $1000! This is a game where you need money to make money.
I’ve matured a lot since I was 18 years old. One way you can tell would be by looking at my investment account! I find myself making less and fewer trades as time goes on, as I recognize there are better places to focus my efforts. This has benefited both my account balance and myself (on a psychological level — I’m less stressed now).
As of now, I’d call myself an Active Investor. Where do you fall in this matter?
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Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.