Day trading or long-term investing? Actively trading the markets or reaping the rewards in the long run?
If you can’t decide what approach is best for you, here are a few tips, pros, and cons of both day trading and long-term investing.
What is Day Trading?
Day trading is a popular trading style that involves opening and closing trades within the same trading day. A day trader opens trades early in the morning or during the day and aims to close his trades by the end of the day. Learn more about day trading here.
Doing this, day traders avoid overnight risks of unexpected events or news that could have a negative impact on their open positions.
Given the large number of trades that day traders take, day trading is an active and fast-paced trading style. To reap the most profits out of the markets, day traders need to actively manage their trades during the day.
While many traders close their trades ahead of important market reports or when their trades hit their profit target, some day traders don’t have a pre-specified profit target and simply aim to ride the intraday trends as long as they last.
There are three essential trading strategies used by day traders to profit from short-term price movements
- Breakout (momentum)
Momentum strategies are nowadays mostly dominated by algorithmic trading programs, so adopting a longer-term day trading strategy, such as chasing intraday trends on short-term timeframes, could return better results in the long run.
What is Long-Term Investing?
Unlike day trading, long-term investors have a different approach to the markets. They are not interested in short-term price movements but in the long-term growth of the markets and their investments.
While day trading is often referred to as active trading, because traders need to actively pick and manage their trades, long-term investing is considered passive.
Investors often follow a “buy-and-hold” approach; they buy stocks or other assets and wait for their value to increase in the long-term. They are not concerned with short-term price movements, even if the market goes against them.
Stock markets have a strong track-record, and long-term investors aim to take advantage of that. Historically, the S&P 500 index has grown 8% per year on average.
Even if you have invested at the start of a bear market, you would still be able to make a profit after 10 years, which was the longest period the market took to make a fresh high in the last 100 years.
Just like day traders, long-term investors can be either aggressive or conservative in their investment approach. Owning a portfolio that consists mostly of stocks is considered riskier than a portfolio that is mostly invested in bonds. Similarly, investing in growth stocks is often considered riskier than investing in value stocks with strong financials and regular dividend payouts.
Pros and Cons of Day Trading
Day trading offers higher profits
Being an active trading style, day trading offers a higher profit potential than investing.
However, this comes with certain risks as well. If you don’t know how to day trade, how to read the clues the markets give to you, and how to control your risk in any single trade, chances are you’ll lose money day trading. In fact, many day traders do lose over the long run because of the aforementioned reasons.
On the other side, if you have enough screen-time and trading experience, control your risk, and actively manage your trades, you’ll likely outperform your long-term investing peers.
Day traders have more opportunities
Day traders follow the market every day to find tradeable opportunities. For example, if the market enters a bear market because of lower risk appetite (e.g. Middle East tensions, Brexit, Greek debt crisis, etc.), day traders will likely be the first to open their positions and profit from the sell-off. Long-term investors will see their investment value falling during those times.
Trading costs are higher
More trading means higher trading costs. Day traders open multiple trades per day, and trading costs can eat up a significant portion of their overall trading profits. That’s why many day traders prefer to trade only the most active hours during the day, such as the NY-London overlap for currencies or the stock exchange open for stocks.
The higher the liquidity, the lower the spread (the difference between the bid and ask price), and the lower your trading costs. Still, trading costs while day trading will be significantly higher than with long-term investing.
Losses can be large
Since day traders trade with higher risk levels than long-term investors, the potential losses can be higher as well.
This is especially true when trading on high leverage. Leverage refers to opening a higher position size by allocating a small portion of your trading account as the margin for a trade and is heavily utilized by day traders. Bear in mind that leverage magnifies both your profits and losses.
Pros and Cons of Long-Term Investing
Buy-and-hold is less time consuming
For the average investor, long-term investing is significantly less time-consuming. With a buy-and-hold approach, you’re investing in the market for the long-term. Many investors invest for their retirement with a holding period of 20, 30, or even 40 years.
Occasionally, long-term investors will rebalance their portfolios to match the current economic climate. They may increase the share of growth or value stocks in their portfolio, or increase the share of bonds to reduce their overall portfolio risk.
Markets rise in the long-term
Another advantage of investing is that markets know only for one direction in the long run – which is up. The S&P 500, Dow Jones, FTSE, and DAX have all generated positive annual returns, on average, since their inception. As the economy grows, company earnings grow as well, which makes their shares more valuable over years.
Compared to day trading which can be risky if you don’t get the basics of trading right, we’ve got dozens of free trading courses where you can learn about trading the markets. Long-term investing is almost guaranteed to make you money when looking at the past performance of the stock market. However, less risk also means lower profit potential.
Lower profit potential than day trading
As mentioned, long-term investing is fairly safe if you invest over a period of many years. But still, the profit potential is multiple times lower compared to day trading.
Whether you should day trade or invest over the long term depends on the goals you want to achieve:
Are you ready to control your risks and manage your trades actively, hour by hour, to make more money as a day trader? Or do you want to reap the rewards passively after many years of investing?
How to Start Day Trading?
Starting day trading is relatively simple. All you have to do is open a broker account, and you’re ready to place your first trade as soon as you fund your account. Learn more about how brokers work.
Most online brokers offer trading on the most popular asset classes, such as stocks, bonds, forex, metals, oil, and gas. Leverage is also widely available to retail traders, starting from 5:1 on stocks to up to 200:1 or even 500:1 on major currencies.
But bear in mind trading on very high leverage can easily backfire and cause huge losses, potentially even blowing up your account.
Once you open your day trading account, you’re ready to join millions of other traders in the market. However, as we explained earlier, successful day trading requires screen-time, experience, patience, and discipline to follow your trading plan. If you lack any of those traits or don’t know how to manage your risk to squeeze the most profits out of the markets, you’ll likely have a hard time becoming a profitable trader.
At My Trading Skills, we believe that nothing can beat market knowledge and clearly-defined trading rules. That’s why we’ve created a detailed Trading for Beginners course hosted by expert traders with live weekly webinars, using live markets, to help you reinforce your trading knowledge.
How to Start Long-Term Investing?
Just like day trading, long-term investing requires a broker account that allows you to buy the financial instruments you want to hold. After your account is set up and active, it’s time to decide on the investment approach and your market portfolio.
- Do you want to lean more towards riskier assets, such as stocks?
- Or, do you prefer risk-free government bonds?
- How about adding some precious metals to your portfolio to keep up with inflation?
You should have a clear picture of your portfolio before you even buy your first stock.
- Invest regularly: The best results with long-term investing are achieved if you invest regularly in your portfolio. Most long-term investors have an outside income, such as earned income and invest a part of that income into the markets every month or year. Even if you’re only able to invest $200 per month, make sure to regularly invest in your portfolio to reap the rewards of compounding.
- Choose an asset allocation model: Asset allocation refers to dividing your investments among different asset classes to achieve your investment objective. The main goal of asset allocation is risk diversification by investing in asset classes that are not correlated with each other.
There are three main asset allocation models:
- Capital preservation models have the main purpose to preserve the initial capital and provide the investor with liquidity. Up to 80% of a capital preservation portfolio would be based on treasury bills, commercial papers, and other short-term money market securities.
- Income-oriented models are designed to provide a steady cash flow by investing in high-quality government and corporate bonds with coupons, and high-quality stocks with a long track record of dividend payments.
- Growth-oriented models are designed to provide the highest growth rate in the long-term. That’s why growth-oriented portfolios mostly consist of stocks.
Tips for picking the best stocks in an income-oriented portfolio
Which is arguably the most popular model among long-term investors.
- Company size: Pick a company that has a large market capitalization and high annual sales.
- Financial condition: Strong financials of a company means a higher-quality stock. Make sure that the company’s current ratio (total current assets / total current liabilities) is at least 2.
- Earnings history: For an income-oriented portfolio, pick companies that have had positive earnings in the last 10 years or more.
- Dividend payments: Income-oriented portfolios rely on companies that have a strong track-record of dividend payments. Look out for companies that have continuously paid out dividends for the past twenty years.
- Price-to-earnings ratio: It doesn’t hurt to invest in companies with a price-to-earnings ratio that don’t exceed 15. This adds to the growth potential of an income-oriented portfolio.
Final Words: Which Should You Choose?
Day trading vs long-term investing – which should you choose? The answer depends on your goals and objectives.
Do you want to actively manage your trades on a daily basis with a higher profit potential? Are you passionate about the markets and want to feel the pulse of the global economy, tick by tick? Then day trading is for you.
If you’re interested in long-term growth without following your positions daily, then long-term investing is the better choice.
Most of the time, there is no need to choose only one market approach. How about splitting your funds between day trading and long-term investing? Many successful traders do that. They rely on day trading for some short-term cash flow, and on investing for long-term growth.
Credit: My Trading Skills