Pros and Cons of Day Trading Versus Long-Term Investing
Choose One of These Trading Styles, or Do Both.
Day trading and investing are both viable forms of trading, and many traders opt to do both. Day trading is making trades that last for seconds or minutes, taking advantage of short-term fluctuations in an asset's price. With day trading, all positions are opened and closed within the same day. Investing is making trades that lost months, and often years. The decision-making process for a day trade can be quite different from an investment, and different skills and personality traits (although many are the same) are required for each.
Ultimately, doing some investing is always encouraged, as it is a more passive form of income and wealth generation than day trading. That said, if you are just starting out in the markets, and are trying to decide where you want to focus your efforts first, this guide will help you make that decision. Learn about how day trading and investing differ in terms of capital requirements, time commitments, skills and psychology requirements, and potential returns.
Day Trading Versus Investing: Capital Requirements
Day trading stocks in the U.S. requires an account balance of at least $25,000. There is no legal minimum for day trading the currency markets, but starting with $1,000 is recommended. Today trade futures, start with at least $5,000 to $7,500.
Investing is typically done in the stock market. Futures have an expiry date, so they aren't ideal for long-term trades. Currencies can be used to trade long-term, but options are limited since there may not always be a long-term trade in a world with relatively few stable and investable currencies (compared to the thousands of stocks and ETFs to choose from, which can also be used to trade futures and currencies indirectly).
Depending on how a person opts to invest, the starting capital required will vary. Let's assume a person wants to own at least three stocks or ETFs. There is no set minimum a person needs to invest, but commissions should be considered carefully when making purchases with small amounts of capital. Assume a commission charge of $7 per trade. If buying $100 of stock at a time, the commission works out to a 7 percent fee. That's steep! Compare this to a person who buys $1,000 of stock at a time; the $7 fee is only 0.7 percent of the capital.
While the commission stays the same, when compared to capital invested, the fee is much more expensive in small amounts of capital. And remember, you pay another commission when you sell. That means that on a $100 investment you need to make 14 percent just to break even, a much bigger handicap than the person who invests $1,000 at a time and only needs to make 1.4 percent to break even. Deploying capital in larger chunks is much better.
Try to save up at least $1,000 before making a stock or ETF purchase (many ETFs can be invested in commission-free, with some brokers). This way, commissions don't take such a huge (percentage) chunk of your capital on each purchase. Saving $1,000 and investing it is far better than buying $100 worth of stock each month. This also assumes that you are doing your own buying of stocks. If you invest monthly into a work contribution plan, typically the money is put into a mutual fund (or several) for which there is no upfront fee (instead fees are deducted yearly, typically at a rate of 1 percent, sometimes with additional fees when funds are withdrawn).
Summary: For investing, if you are buying your own stocks, try to save up at least $1,000 before making a purchase. With each $1,000 (or more), make an additional purchase, slowly expanding the portfolio to three or more stocks and ETFs. If you don't need to pay commissions (on some ETF purchases, or to a company investment plan, for example) then you can invest money as you have it. For day trading, you are going to need at least $1,000 for trading currencies, $5,000 or more for trading futures or at least $25,000 for day trading stocks.
There is also a middle ground between investing and day trading called swing trading, which is when trades last for a few days to a few months.
Day Trading Versus Investing: Time Commitments
Day trading requires a daily commitment, typically of at least two hours. The first hour that U.S. markets are open (officially) for trading is typically one of the best times to capitalize on large price moves. As lunchtime approaches in New York, stocks tend to quieten down. The best "bang for the buck" comes from trading that opening hour or two, with a bit of prep time before the open. Day traders should also spend time reviewing their trade each day and at the end of each week. Total time commitment: about 15 hours per week on the low end, and up to 40 hours per week on the high end (if trading most of the day).
Day trading is done when the market is open and active. The most active time for stocks, currencies, and futures is near the U.S. stock market open. Alternatively, global markets also tend to be active (especially currencies and European stocks) near the European open. If in the U.S. or Canada, these are ideal times to trade, which means trading in the morning or the middle of the night. If these options don't work for you, day trading may not be a good fit, and you are better off investing.
Investing, and mainly the research that goes into it, can be done at any time, even if someone works a lot of hours at a job. When capital is ready to be deployed, expect to spend a couple hours per month looking through stocks and finding which ones meet the criteria of your investment strategy (finding or creating an investment strategy will take up more time in the beginning).
Some people, that want to be more active, may end up spending a couple hours per week doing research (especially if they have lots of capital to deploy and are looking for multiple trading opportunities). For the "set and forget" investor, they may only need to do a bit of research, or check on their investments, every few months, possibly when they are ready to make another purchase.
Summary: Day trading takes a significant time commitment; think of it as a part-time, if not a full-time, job. It is best done near the U.S. market open, and alternatively at the London open (for currencies or European stocks). Investing takes up much less time. Active investors may spend a couple hours per week researching and placing trades, but more passive investors may only need to commit a couple hours every month or two (assuming they are managing their own investments).
Day Trading Versus Investing: Skills and Personality Requirements
Any sort of trading requires a serious time commitment up front to research and create a strategy that works. It then takes time to learn how to implement that strategy effectively, as new traders will often deviate from their plan or strategy because of the strong emotions that inevitably arise when capital is on the line.
Day trading and investing both take discipline. Trades must be taken and exited according to specific trade triggers provided by the strategy. Trading when a trade trigger is not present is undisciplined and likely to lead to poor performance.
Day trading and investing both take patience, but a different sort of patience. Day traders are active, potentially taking many trades a day. But they still need to wait for their buy and sell trade triggers to occur. Watching each little price movement can easily seduce a trader into making a trade when they shouldn't. On the other hand, investors also must only act when a trade trigger occurs. They are not constantly watching their positions and worrying about every penny it fluctuates (or, at least they shouldn't be), therefore, the temptation to trade is there less often.
None the less, the investor must still learn to only take trades when a valid trade trigger occurs, even if that means looking through charts for weeks without finding any good opportunities.
Day trading and investing requires smarts, but not necessarily book- or college-smarts. Reading a book doesn't make money. All traders must convert the book-smarts into usable knowledge. That means distilling everything down into a few simple concepts that you find easy to follow. So read books, and take from them what you like. Do this until you have a method for entering, exiting and managing risk on your trades. Test out the method on historical data to see if it works. Then, get comfortable making trades in a demo account.
Then, when ready, implement the strategy with real capital. Occasionally, some tweaks may need to be made to the system as you gain experience and find better ways of doing things.
Summary: Day trading and investing are both tough, and require patience, disciple and smarts (but that doesn't mean you need to go to business school). Day traders watch their charts all the time, which means they can be easily seduced by mediocre opportunities. They also need to enjoy sitting in front of a computer all day, alone (typically). Investors don't need to sit in front of their charts all day, but they still need the discipline and patience to act only when their strategy calls for it.
Day Trading Versus Investing: Potential Returns
For informational purposes, we will compare potential investment returns and day trading returns, but it's like comparing apples to oranges.
As discussed, day trading takes a lot of time, and investing takes a lot less time. Investing can be done with millions of dollars with little impact on performance, whereas day traders will likely start to see a decline in percentage performance even with an account of several hundred thousand dollars (it's harder to deploy more and more capital on trades that only last minutes).
Because of these discrepancies, we see a big difference in the potential returns of investors versus day traders.
Day traders can make 0.5 percent to 3 percent (on the high end) per day on their capital. That could equate to 10 percent to 60 percent per month. The higher return percentages may be possible on smaller accounts, but as the account size grows, returns are more likely to shift into the 10 percent/month region, or lower.
With day trading, gains compound quickly. If starting with $30,000, and making 10 percent per month, the next month the trader is starting out with $33,000. If they make 10 percent again, they are up to $36,300. Compounding occurs daily since profits are locked in daily. That means gains are made on prior gains (in addition to deposited capital) so an account can balloon quickly. Unfortunately, a day trading account can also decline rapidly if a trader is losing even 1 percent or 2 percent of their capital per day.
Most individual investors don't need to worry about accumulating too much capital. With loads of stocks out there to choose from and a longer-term time frame to accumulate and dispose of positions, the long-term investor has averaged about 10 percent per year. That is over a long time frame though, as any given year could see returns much higher or lower than 10 percent (with negative returns occurring about one out of every four years). Active and skilled investors can outperform the 10 percent average, as certain strategies have shown a tendency to produce 20 percent or more per year.
Since investments are often held for years, the compounding is slower. If trades last several years until the profits are realized those gains can't be used to produce more gains. This is one advantage of shorter-term trading--rapid compounding. As mentioned though, it is harder to deploy more and more capital on short-term trades, so doing some long-term investing (as well as some possible short-term trading) is encouraged.
Summary: Everyone should invest for long-term wealth accumulation. The only decision is whether a trader also wants to take the time to compound capital very quickly by trading daily. Day traders can make upwards of 10 percent per month, whereas investors are more likely to make 10 percent to 20 percent per year.
Final Word on Day Trading Versus Investing
Doing some investing is recommended. It is a good way to build passive income/wealth, without having to dedicate hours each day. Investing may only take a few hours every few months to manage positions and look for new trades, although some investors may opt to put in more time. Day trading is viable if looking to generate an income or extra income, and you have several hours (typically at least two or three) per day to dedicate to the task.
If investing on your own, buy stock in at least $1,000 bundles. Investing lots of small amounts will incur too high of a commission cost. For day trading, it is recommended traders start with $1,000 (or more) for currencies, $5,000 (or more) for futures, and $25,000 (or more) for stocks.
All types of trading require patience, discipline, and smarts. Research and compile a trading method that works for you. If you don't mind being glued to a computer for part of the day, then day trading is an option to consider.
Returns aren't really comparable for day trading and investing. Over longer periods of time, individuals can invest virtually unlimited funds and attain a decent return. Day traders are capped in how much they can deploy on short-term trades. That said, day trading can provide a very comfortable lifestyle and above average income (many traders also lose everything) for those who dedicate the time required to mastering it.
If opting to day trade, also set aside some funds to invest. Investing means having funds for a rainy day, and hopefully, those investments grow over the long-term to increase wealth.