Pros and Cons of Trading vs Investing
What's the difference between trading and investing and what are the pros and cons of each?
If we take an extreme example of "day-trading" versus "buy and hold" investing, there is a huge difference, both in terms of the possible returns and the risk involved. This article looks at the pros and cons of each method of making money from the markets and from stocks and shares.
What's The Difference Between Trading and Investing?
Traders make a living mostly from profits earned from trades: i.e. buy low, sell high and spend the capital gain. Investors buy assets, then live mostly off the dividends and sell far less frequently.
e.g. A Day Trader buys in the morning, on the basis of news items, company or government reports and technical analysis and sells in the afternoon once the expected, big move in price occurs and sleeps easy at night.
A "Buy and Hold" Investor buys value stocks regularly and lives off the dividends.
Most people fit somewhere between these two extremes or may run both styles of portfolio. The possible returns from trading are huge, but the risks even greater and the income from "Buy and Hold" strategy may be rather pedestrian, but here are some suggestions to find the best approach for you.
Pros and Cons of Investing Versus Trading
So how do they two approaches compare?
Day Traders may look for stock that will move by a few percent today then sell. e.g. if you had $50,000 and you bought five stocks for $10,000 each hoping for a 5% gain on each with a strict limit at 5% (i.e. take profits if it hits that) and a strict stop-loss at -2.5% (i.e. sell and lick your wounds at a 2.5% loss) you could make $2,500 per day or lose $1,250 and even if you got two right, two wrong and one didn't move you'd still have a $1,250 per day (minus dealing costs) just for being random. Easy money? What if the stocks don't move and you have to sell them at the end of the day or all go down. If that happened for several days in a row you would eat into your $50,000 working capital and you still have to eat and pay the mortgage. Which is why so many "day-traders" went bankrupt at the start of the decade.
Long-term buy and hold investing however will approximately pay you inflation plus a small dividend. You live off the dividend of maybe 5% (or even 3%) so you need $1,000,000 just to pay an average income (plus inflation) or if you invest in index-linked government bonds (the only really safe investment) you would need $2,000,000!
This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.