Retail investors (also called casual investors) are those whose primary income does not come from the stock exchange. Instead, they earn a living through other means, like employment or business ownership, and often conflate stock investing and stock trading.
These investors may contribute a small percentage of their wages or paycheck to a retirement account, making them a long term investor. It’s a far cry from trading based on daily market trends.
Trading and investing are quite different. A successful trader seeks short term profit from market fluctuation using the volatility of the stock market combined with a particular trading style. They may buy and sell actual stocks or engage in ancillary markets like options trading. The risk tolerance for a swing trader is significantly higher, and their work might even be compared to that of a professional poker player who is excellent a judging the odds of winning.
By contrast, a successful long term investor buys stocks and holds on to them for months, years, and possibly decades, seeing long term capital gain from the growth in portfolio value and dividends produced by individual share of stock. The risk tolerance of a long term stock investor does not need to be as high as that of someone placing one day trade after another, because generally speaking, long term stock investors are betting on a business to succeed, while short term traders do not care about the business as much as they care about the metrics going up and down.
Let’s take a deeper look at some of the differences between trading stock and investing in stock, then you can consider whether trading or investing is better for you.
Trading vs Investing: 5 Key Differences
1. Length of Time
Stock market trading is a short term activity. A trader who buys a stock might hold on to it for a few weeks, a few days, or even a few hours before turning around and selling it off.
Investing in the stock market, by contrast, is a long term activity. It involves a commitment of years (if not decades) of buying and holding stock—both to see the stock price grow over time and to benefit from any dividends issued by the company.
A trader will often do business from a trading account or brokerage account that does not carry tax penalties for liquidating the assets. A stock investor might also use a brokerage account for long term purchases, but most retail investors benefit from using a tax deferred or tax sheltered account, like an IRA or 401(k). Incidentally, a day trader (as a stock trader is often called) who wants their trading activity treated like a business for tax purposes must meet certain criteria, including maintaining a minimum balance of $25k in their trading account.
Trading is a riskier activity for most individuals because it relies on market movements as opposed to long term growth. Market movements are difficult to predict, mainly because there is a clear lack of precedent about what might happen next (though it’s possible to do a little deeper digging based on the behavior of stats). Unfortunately, even the best computer programs in the world cannot predict geo-political events that can throw off the stock market.
By contrast, investors in the stock market rely on the precedent of established, long term growth over the course of decades. The number of factors that can turn short term buying and selling of stock unprofitable puts trading into a riskier type of stock market activity. Even though there are huge gains to potentially be made by buying and selling a stock at the right time, actually benefiting from these dips and bumps is harder than letting an investment in the stock market steadily grow over the course of decades.
For a successful day trader, a 10 to 20 percent rate of return is considered good—with the average hovering around 10 percent. However, 95 percent of day traders do not make money (to put it bluntly).
By comparison, the stock market during the past 90+ years has seen an overall increase of 9.8 percent. A particularly well-managed mutual fund or stock portfolio might be able to boast a slightly higher return. That said, most individual traders would be better off with a long term strategy of buying and holding. This is because only around five percent of traders make money, and the money they make is frequently about the same as the long term gain of buying and holding stock for life.
If, however, you know what you are doing, day trading can yield significantly higher earnings because traders can dump stock when it peaks and buy it when it dips, maximizing profits far beyond what it would be if they were just relying on the average growth between highs and lows over years or decades.
For a retail investor putting five percent of their paycheck into a 401(k) or IRA, the only skills needed are consistency and patience. However, for stock investors who play a more active role in the creation of their portfolio, fundamental analysis of a company is important. This includes looking beyond metrics like stock price and the 52-week highs and lows to examine operations, revenue, market share, and other relevant factors that help an investor determine whether or not they’d like to be a part owner of the business (through their stock shares).
For traders, skillsets are less about fundamental analysis and more about the data analysis of numbers and trends over time in the financial market, usually with the assistance of software programs. Long term investors outside of casual retail investors also need to be skilled at understanding factors outside the stock market, such as the overall economy, and other related factors like geopolitical trends. They too, are often looking for the next big thing, but with the intention to get in on it for the long haul and not just to capitalize on price swings.
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As mentioned, there is a big difference in the way traders and investors look at the stock market. At the core of an investor’s trading strategy is the decision as to whether or not they would want to be part owner of said company—because a share of stock is really a share of ownership in a company, and the stockholder will share in the company’s fortune, misfortune, growth, or stagnation—times however many shares they purchase.
By contrast, a trader does not always care about the company itself. They are more interested in capitalizing on the data of market movements. To that end, math, analytics, algorithms, and software assisting in these types of calculations is of the utmost importance. Many traders rely heavily on a software to reveal algorithms that can assist in predicting future behaviors based on the probabilities and odds exhibited in past results.
Trading vs Investing: Which is Better?
To be perfectly honest, for the vast majority of people, investing is a better approach. Remember that of the five percent of traders who are financially successful, 10 percent is an average-sized return. Consider the fact that the stock market has seen 9.8 percent increases over the last nine decades, it’s a lot of work and risk compared to just from parking your money in an index fund and letting it ride.
But if you have a good head for math and data analysis, and can afford to purchase the supporting software, then profiting from the ups and downs of the stock market might be for you. Keep in mind that day trading is not really counted as a passive income source because so much work goes into analyzing the market on a daily basis.
Despite the fact that you may think of a day trader as someone who brews a cup of coffee, commutes to the couch, and presses a few buttons on their phone or laptop before checking out for the day, day traders are anything but that. Day traders are constantly crunching numbers, analyzing data, and perhaps even meeting with company executives, advisers, or other traders throughout the day. In fact, many of them work more than one would at a typical nine-to-five, but like many self-employed entrepreneurs, it’s because they love what they do.
Again, for most people with disposable cash to spend, trading can be a ruinous activity. You probably know a few people who are adverse to any sort of investing because they bought a stock that didn’t work out. Such individuals would have been better consistently putting a portion of their paycheck into a mutual fund run by a financial advisor or money manager, or purchasing a stock portfolio of large, stable, blue chip companies that issue dividends. In fact, investing experts like Warren Buffet suggest that no more than five percent of a person’s investing income should be parked in untested opportunities, with the other 95 percent parked in a more stable set of stocks, a mutual fund, or ETF. It may not be exciting, but it carries less risk and a far better chance of successfully enjoying the fruits of your consistency and patience.
Learn More About Successful Investing Strategies
Successful investment strategies in the stock market require discipline and guidance. That’s why you should seek advice from experienced individuals who can tell you what works and what doesn’t.
If you’re interested in learning more about the potential wealth building strategies that can be leveraged by investing in the stock market, consider joining Infinity Investing. Our experts can teach you how to build several diverse streams of income that can supplement each other, so even if one is down, others can make up the difference.
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