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Updated on Monday, December 17, 2018
Maybe you’ve been investing for a while and you’re ready to take the next step into day trading. Or maybe you’re still wondering what exactly “day trading” means — and whether you should be taking such risks in the first place.
Although both require investment accounts to get started, stock trading and long-term investing are two very different approaches to growing your nest egg. And depending on your specific financial goals, risk tolerance and stock market savvy, one strategy may make a lot more sense for you than the other.
Here’s a basic rundown of the differences between stock trading and investing to help you make a more informed decision about how, when and where to allocate your assets.
Stock trading vs. investing: at a glance
Stock trading is a short-term approach to the market that’s focused on earning substantial gains right now. However, it can be riskier and more expensive than long-term investing — traders can lose money quickly on the wrong buy and are subject to more trading fees and higher taxes on capital gains.
Long-term investing, also known as the buy-and-hold approach, is focused on long-term gains. Investors allocate their assets based on how they think securities will perform over several years or even decades, riding out market fluctuations to achieve substantial growth down the line.
High earnings in the shortest time possible
Modest to high returns over a longer period of time
Time commitment required
Frequent monitoring of your account and considerable time researching investments and vetting your next purchase
Infrequent monitoring of your account; check in on its performance a few times a year
Immediate losses as well as trading fees and higher tax rates on short-term capital gains (taxed at regular income bracket)
Stock losses over time and lack of substantial gains
High returns in a short period of time
Significant growth over time due to compound interest; relative stability (if properly allocated); long-term capital gains tax benefits (lower than income bracket)
What is stock trading?
Stock trading takes place in the short term, meaning assets are bought and sold quickly, sometimes in as little as a few minutes or hours. There are several different types of stock traders, and their strategies and time frames vary:
- Scalp trading is super short-term investing; scalpers might hold their assets for just a few minutes or even seconds. The capital gains made on each trade are usually quite small, which scalpers compensate for by performing many trades per day to create profit.
- Day trading is the approach you likely think of when you think of a stock trader. These investors start each trading day with cash in their accounts, purchase assets and sell them all before closing time — with the intention of having more cash at the end of the day than they started with.
- Swing trading is the longest-term approach to stock trading, with assets being held for several days or weeks. These investors are hoping to cash in on market trends without having to keep their cash locked away for the long term.
Stock traders are interested in immediate gains, which means they’re generally not buying long-term securities like government bonds or target-date funds. Instead, they might invest in a particular company’s shares in anticipation of a big announcement or new product reveal or bank on fluctuating currency rates with foreign exchange, or forex, trading.
Stock traders generally set rules to help themselves decide when to buy and sell an asset, usually based on a growth percentage. The aim, of course, is to buy low and sell high.
However, because these short-term purchases don’t leave much margin for error or time for market recuperation, substantial losses are possible — and traders also have to pay brokerage fees on each transaction.
What’s more, short-term capital gains (those on assets held one year or less) are subject to higher income taxes than long-term capital gains; traders pay as much on those gains as they would on any other income — which means up to 37%. Gains on assets held longer than a year usually are taxed at a lower rate: no more than 15% for the majority of taxpayers, according to the IRS.
What is investing?
Long-term investing, wherein an asset is bought and held, is all about using the power of compound interest to create substantial growth over a longer period of time — at least a year or two but often several decades.
Instead of banking on short-term market volatility, these investors create a long-term plan and soften their risks by purchasing diverse assets, including multiple kinds of securities in their portfolios — often pre-diversified securities like mutual funds and exchange-traded funds.
Although this strategy sometimes is referred to as buy-and-hold investing, Malik S. Lee, founder of Felton & Peel Wealth Management in Atlanta, suggested a slightly different tack. “I’m a firm believer in the ‘buy-and-evaluate’ model,” he said, stressing the importance of monitoring market performance over time.
Lee said that the average investor probably should re-evaluate their portfolio at least once a year, ideally with the advice of a financial professional. But at the same time, it’s important to remember that this is a long-term strategy — you shouldn’t pull your money out over every little market dip.
“You don’t want to react to a headline risk,” he said, “but in certain situations, you do have to go in there and make a change.” For example, if new legislation is passed that changes the market dynamic or the economy experiences a serious unexpected shift, reallocation may be in your favor.
Stock trading vs. investing: which approach is right for you?
Stock trading requires a significant tolerance of risk and a thorough understanding of the market; traders need to be up to date on business trends and current events at a global level. Even with the best stock algorithms and analyses technology has to offer, stock trading is a risky adventure at best — and high taxes and trading fees can diminish overall earnings.
Long-term investing, on the other hand, is an important part of any saver’s overall financial strategy, particularly for funding retirement. The power of compound interest can turn even modest contributions into a substantial nest egg given enough time and patience. And the IRS has created a number of tax incentives for buy-and-hold investors, from specialized retirement account benefits to lower tax liability on long-term capital gains.
Of course, all investments involve risks, and only you can decide what’s best for your financial future. Just be sure you know what you’re getting into before you click the “buy” button.