This is one of my shorter posts, as previous articles have been written as very long and informative pieces. Every once in a while at Finance and Purpose, I’ll post tidbits of advice to address commonly asked questions.
A lot of people have been asking me what the difference between day trading is versus investing.
Among those who buy and sell stocks there is an ongoing debate about whether the most profitable approach to stock market trading is short or long term investment. And the two sides rarely reach agreement, because one side is rather conservative in its approach, whereas the other has a more radical and freewheeling attitude.
Tortoise vs Hare
Day traders are usually considered the mavericks of the trading world, and they are known for taking gambler’s risks and making huge profits in short amounts of time. Usually buying and selling the same stock several times in a single day. They are speculators that forecast future price changes arising from volatility, and don’t often buy a stock for the soundness of the business.
I also consider day traders as hyper optimizers of their portfolios because they take every advantage of daytime market volatility to increase their return. Investors on the other hand, build wealth over time, from general trends and long term trends and don’t optimize their positions as much.
Those who prefer to buy and hold their stocks follow a more risk-averse path, and cite historical trends and financial analysis to maximize returns. They analyze income statements, balance sheets, and cash flow statements to back up their claim that their method is provide a case for a reliable investment.
Most investors can enjoy the best of both worlds, by setting aside some of their money for day trades, and the balance of it for longer-term investment. Because day trading tends to be more volatile, and can result in quick profits or fast losses, most of us would be advised to put only as much of our investment capital as we can comfortably afford to lose for day trading. That way, even if you encounter a worse case scenario, it will not adversely impact your overall financial situation.
I personally put aside 95% of my portfolio into sound investments and investment vehicles, and use 5% for fun and speculation. It’s more of a hobby than anything if done as a pastime, but people can build real wealth out of day trading. For 99% of people however, day trading a large portion of your money will only make you poor, while your broker gets rich.
Pros and Cons – Find What Fits your Style and Personality
At Finance and Purpose, I advise most people to use a prudent approach to value investing, and low cost index funds. However, some of you reading out there probably have a lot of passion for stock tickers, graphs, and the adrenaline rush. I get that — I used to be that way too, and I think you should definitely try day trading if that fits your lifestyle and preference.
There are pros and cons to both styles. Those who do day trades enjoy the fact that they can get in and out of the market quickly, and make money without waiting for the results. But any kind of stock market investment strategy requires research into the companies you decide to invest in, and research can take time to do. If you are buying and selling so fast that you don’t have time to do adequate background analysis, day trading may not be a prudent approach.
Investing in companies that provide slow but steady returns is a time-tested approach to the stock market. They are commonly known as dividend “Aristocrats” whose business models are sound and their free cash flow is given as cash dividends. These companies have a long history of maintaining a dividend and raising their payouts over time.
In fact, most historical evidence supports the idea that if you buy quality stocks and hold them for long periods of time – at least five years or more – you will do very well in the stock market. For that reason, those who are young enough to have time on their side would probably be wise to invest in stocks for retirement. In my previous post, The Simple Guide on Investing Pt 3 I describe the index fund as the best way to do this.
With most investments, it is usually best to diversify to minimize risk and maximize potential gains. One way to accomplish this in the stock market is to employ both strategies. Use a small portion of your investment capital for short-term trades or into closed ended higher risk funds, while leaving another portion in long term and safe investments. If one basket of investments doesn’t do well, the other probably will. And if both do well, you will enjoy twice as much success.
The Intelligent Investor, by Benjamin Graham, is a great resource for young investors to learn about the market. My favorite style of investing — called Value Investing, is one of the best ways to preserve and grow your wealth.
Graham’s book is a shrine of clarity against all the noise on Wall Street, Mania, Clickbait and Headlines these days. Learn to Think before you invest, and you will surely grow rich.
Check it out and let me know what you think.