When it comes to securities trading, day trading and investing both are viable forms, and many traders opt to do both. Although trading and investing both involve making a profit in the stock market, they pursue the said goal in different ways.
Day trading is primarily done for short-term gains where traders look to cash upon price fluctuations within a short notice. Simply put, it refers to a practice of buying and selling stocks, commodities, and other financial instruments frequently, sometimes even within a day.
Investing, on the contrary, refers to a strategy where you hold on to your investments for a much longer period, which ranges anywhere from 5 years to 15 years. It is considered as one of the ways to make substantial gains from the stock market and equity mutual funds investments for investors who remain committed for long periods.
Differences Between Day Traders and Investors
Here we are discussing the top 5 Â differences between the two –
1. Approach
The first key difference between day traders and investors is in the approach. Although both of these make money from the stock market, day traders use technical analysis to base their buy and sell decisions, whereas investors primarily use fundamental analysis to make money from the stock market.
The technical analysis used by day traders takes the market price of the free stocks into consideration to predict future patterns and analyze historical ones but does not bother too much with analyzing factors affecting the market price. It typically studies trends in volumes, prices, and moving averages over a period of time.
The fundamental analysis used by investors, on the contrary, focuses on studying the financial health of the industry, future growth prospects of the company, and the general macroeconomic situation in the country.
2. Risk Involved
There is no doubt about the fact that both trading and investing imply risk on your capital. However, day traders are prone to comparatively higher risk, and higher potential returns as the price might go high or low in a short while.
To help reduce the risk associated with day trading, the pattern day trading or PDT rule was implemented for day traders back in 2001, mainly as a safety feature.
PDT rule is essentially a designation from the Securities and Exchange Commission (SEC) that is given to the day traders who make four or more day trades in their margin account over a five business day period. For instance, if you have a $2,000 account, you can only make three-day trades in any ongoing five-day period. Once your account value is above $10,000, the restriction is taken off.
Investing, on the other hand, involves comparatively lower risk and lower returns in the short run but might deliver higher returns in the long run by compounding interests and dividends. Further, daily market cycles do not affect much on quality stock investments for a longer time.
3. Time Horizon
The other main difference between day traders and investors is their activity levels and position holding times. While the day traders are involved in active management with a short-term holding period, investors are mainly involved in passive management with a longer-term holding time horizon, usually spanning from multiple years to decades.
The primary focus of day traders is on short-term trades contained in a single trading day, utilizing direct-access trading platforms. In contrast, investors tend to monitor their portfolio positions on a periodic basis through statements and online browser-based platforms.
For example – If you buy a stock today and hold it for the next three years, then you are investing with the belief that the price of that stock will be much higher after three years than what it is today.
Whereas, if you buy a stock today morning and are prepared to sell the same by evening (before the market closes for the day), then you are trading. Here you are primarily of the opinion that you make a profit by the difference in your purchase and selling price.
4. Types of Stocks
Day traders have completely different criteria as compared to investors when looking for stocks. Instead of being concerned with factors such as long-term potential, management team, etc., of a company, they are focused solely on price action. Day traders generally look for stocks with momentum and volatility to be able to create the opportunity and take advantage of significant price action.
Investors, on the other hand, are primarily focused on good companies with growth potential in the coming years. They tend to look for safer stocks from more responsible and legitimate companies and like to stay away from volatility as it could represent instability to them.
5. Generating Cash Flow or Investing Cash Flow
In general, a day trader’s endeavor is to generate positive cash flow through intraday trading. However, the investor’s aim is to invest his surplus cash generated from the stocks kept for the long term. Unlike day traders, investors are in no hurry, making the rules of the game very different for them.
To Wrap
Day traders and long term investors follow two vastly different approaches with the common goal of creating wealth in the stock market. Trading involves more frequent buying and selling of stocks, with the goal of generating quick returns. Investing, on the other hand, entails building wealth gradually over an extended period of time following the approach of buying and holding stocks.
However, if you’re planning to choose one approach, it is important to think about the time that you can spend on a daily basis on market activities. If you can daily spend hours in the market, trading is best for you. Otherwise, investing is a better approach.
Further, it also depends on your knowledge of the stock market. If you are an avid reader and like to read financials, account economy, etc., then investing is good for you. On the contrary, if you are good at financial trends and charts, trading is the better option.
