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Key Differences Between Day Trading And Investing

The rise of the retail army in equity markets has drawn our attention to a big misconception we often see online—that there is little difference between day trading and investing.

The truth is that day trading and investing are two completely different investment strategies. This article discusses some of the key differences between day trading and investing that are not just about the holding period of stocks.

Key Differences Between Day Trading and Investing

Yes, the obvious difference between day trading and investing is how long stocks are held, but this article discusses some of the less obvious differences between the two.

1. Capital Allocation

Day trading involves same-day buying and selling of stocks, capitalizing on small price movements that occur in stocks that are highly liquid. Typically, the day trader makes volume buys, then sells as the price (hopefully) increases, making a gain by the time the market closes.

Investing, on the other hand, involves buying stocks with the intent to hold on to them, allow them to gain value, and potentially sell them once they reach a certain level of value. Some investors, otherwise known as income investors, may hold on to positions for a longer period of time as a source of independent cash flow, assuming it still makes sense from a valuation perspective, thereby seeking an overall total return approach to investing in the stock market.

This means that a key difference between a day trader and an investor is their approach to capital allocation. A day trader allocates capital by identifying short-term opportunities from price fluctuations to enter or exit positions during the trading day, whereas an investor allocates capital by looking at the intrinsic value of stocks and enters positions (only when determined appropriate) during the trading day with a longer term view.

2. Technical Analysis vs. Fundamental Analysis

Due to the difference in length of the holding period, there is also a key difference between day traders and investors in how they make buy and sell decisions.

Day traders rely more on technical analysis—looking at stock charts that help the day trader visualize price actions, as well as technical indicators, which in simplistic terms are mathematical patterns derived from historical data to help forecast price actions—to make buy or sell decisions.

Investors, on the other hand, may use technical analysis but generally also rely on fundamental analysis—looking at the intrinsic value of a stock and conducting economic forecasts based on research to assess the stock’s long-term growth potential (and income, in the case of income investors).

3. Closing Positions

Lastly as you can expect, day traders close out on all their positions at the end of the trading day, whereas an investor continues to hold on to their positions based on their forecasted long-term growth potential.

For day traders, closing out at the end of the trading day is important. Some of the reasons include:

  1. the risk of holding onto trades overnight, because prices still move between the close of the market and its next opening due to buy and sell requests that build up overnight, triggered by factors such as a significant economic data release, an unexpected natural disaster and other overnight news;
  2. volatile stocks typically having big opening price differences since the close of the market on the previous day, and even if the trader has a stop loss order (automatic order instruction to sell when a stock falls to a specified price), it may not provide protection since the order will fill at the nearest price during the day, which may be significantly lower than where you intended to cut ties; and
  3. there may be overnight fees and leverage requirements for overnight trades, and day traders also close out their positions at the end of the trading day for good discipline—to start fresh the next trading day even if losses are made.

In stark contrast to day traders, investors with time-tested investment principles stay fully invested in their formal asset allocation strategy and make few changes to their positions. This does not mean that investors buy and hold forever, but rather that investors have a plan, stick to it, and adjust only when necessary to reach their financial objectives.

The Bottom Line

It is vital that you look beyond the hype of widely marketed success stories and understand the underlying risks of day trading. Though not entirely impossible, consistently making money as a day trader is difficult and a high-risk strategy in which to invest your hard-earned money: there is a distinct possibility that you may lose some or even all the money that you put in. If this has not impacted your interest in day trading, be sure to speak to your financial advisor to understand how your capital gains and losses are treated to understand your tax implications—determining if you are a day trader versus an investor may impact how much you pay in taxes.

When done prudently and patiently, investing, while not without risk, is one of the less risky strategies that will enable you to build wealth—it is important to find the right balance between maximizing your investment returns and the level of risk you are willing to accept.

Alternatively, you can hire a professional to build and grow your wealth for you. In Canada, the Portfolio Management Association of Canada (PMAC) is a forum for Portfolio Management firms to share best practices and industry knowledge. PMAC Members manage investment portfolios for private individuals, foundations, pension plans and more. Through PMAC’s Find a Firm page, you can find a member that matches your needs, filtered by the type of account you are interested in, your monetary range, and your province of residence.

Ready to start a conversation? At Bloom Investment Counsel, Inc., we seek an overall total return approach for our clients through capital gains and dividend income—so that your money is working for you. View our PMAC profile here.

This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.

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