Comparing stock trading and investing is like comparing a Maserati with a Volvo. They’re both cars, but that’s about where the similarities end. Trading and investing both involve making money in the stock market, but they do that in different ways. Here’s how.
Trading vs. investing: Two big differences
Like a Maserati driver, a trader puts the pedal to the metal, jumping in and out of stocks within weeks, days, even minutes, with the aim of short-term profits. Traders often focus on a stock’s technical factors — say, trends in its share price — rather than a company’s long-term prospects. What matters to traders is which direction the stock will move next and how the trader can profit from that move.
Investors have a longer-term outlook. They think in terms of years and often hold stocks through the market’s ups and downs.
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Timing is the starkest difference between traders and investors, but their focus also differs dramatically. Investors study a company’s potential for long-term growth or value, but traders often take advantage of small mispricings in the market, such as when political uncertainty in a foreign country temporarily pushes down the share price of a U.S. manufacturer.
Once the temporary mispricing is corrected, a trader will move on to find the next temporary mispricing.
“Once the temporary mispricing is corrected, a trader will move on to find the next temporary mispricing,” says Ryan Bayonnet, founder of Hyland Financial Planning in Akron, Ohio.
So-called scalp traders might be in a position for just minutes. Day traders are focused on the trading day, while swing traders invest for days or weeks.
Why people trade stocks
- Money: The opportunity for big profits exists, though few amateur traders succeed over the long haul.
- Entertainment: “It’s enjoyable,” says Larren Odom, founder of Chastain Wealth Management in Atlanta. Still, he’s a strong advocate for investing, and he suggests trading no more than 5% of your investable assets. Here’s more information on the safest way to day trade.
- Education: It’s a good way to learn how the markets work, says Matt Saneholtz, a former professional trader and now co-owner of Tobias Financial Advisors in Plantation, Florida. But he, too, advocates investing, not trading, to reach life goals.
If you’re interested in trading, here are some tips for minimizing risk:
- Create a plan that dictates when you’ll buy and sell. For example, you might decide to sell if a stock rises or falls a certain percentage.
- Stick to your plan. Even experienced traders let their reasoning for holding certain stocks shift. “That’s the hardest part of being a trader, sticking to your rules,” Saneholtz says.
- Figure out how much money you can afford to lose, and don’t trade more than that.
- Go in with open eyes. “The most advanced traders use sophisticated algorithms to trade on any small inefficiencies in the market,” says Kirsty Peev, a portfolio manager at Halpern Financial in Ashburn, Virginia. “The margin of opportunity is so slim now. They may be aiming for a 0.01% gain on millions of dollars. The average person is priced out of this playing field.”
- Know your taxes. You might be able to take a tax deduction for trading costs, but you might also owe taxes. Rates on short-term gains range from 10% to 39.6%. See what you’ll owe on short- and long-term capital gains.
Why people invest
Investing is a way to build long-term wealth. Just ask anyone who bought stocks in March 2009 — the Standard & Poor’s 500 index is up about 270% since then.
A recent NerdWallet study shows investing in the stock market can return millions more retirement dollars than putting money in a traditional savings account or keeping it in cash.
- Create an investment plan for buying, selling and rebalancing your holdings. For example, some people sell some holdings and buy others to get the portfolio back in line with original goals after market moves have pushed it out of whack.
- Be prepared for the long haul. You’ll need patience and discipline to stick through the market’s ups and downs.
“Trading may feel good in the short-term,” says Brian Schaeffer, an advisor with ShankerValleau in Skokie, Illinois, “but as an investor, time is your best friend.”