There are two main groups of people in the financial industry. On the one hand, there are long-term investors like Warren Buffett and David Einhorn who believe in buying quality companies and holding them for months or years. On the other hand, there are people who strongly believe in day trading.
Both of these sides are correct since many people have made a fortune using the two strategies. Some, like Warren Buffett, have made money buying and holding stocks for years and decades. At the same time, some, like James Simmons of Rennaisance Technologies have made a lot of money as traders.
The two approaches are not the same, however, and many people believe that trading in short time horizons is more dangerous. But will this be true?
In this article we are going to see if day trading is really riskier than investing, or is this just a false belief.
Different approach for a different career
There are differences between investing and day trading. Investing is the process of buying and holding financial assets for an extended period of time.
In most cases, investors buy stocks they believe are cheap and then hold them for a while. They mostly focus on fundamental analysis, which is the process of finding out the intrinsic value of assets.
On the other hand, trading is the process of buying and selling financial assets with he goal of making a profit. Traders have an extremely short-term horizon.
For example, some of them who are known as scalpers usually enter and exit trades within less than 5 minutes. Their goal is to make small profits numerous times per day.
Another unique difference is that day traders are always afraid of leaving their trades open overnight. Also, they mostly focus on chart analysis instead of fundamentals. In many cases, it is possible for a trader to trade stocks they don’t know.
Related » Scalping vs Day Trading
Day trading risks
Day trading is a very profitable approach, but it also has risks that every trader should absolutely watch out for.
Leverage risk
In most cases, day traders use leverage to day trade. Leverage is a situation where people use borrowed money to trade.
The risk is that a trader will make substantial losses when the trade or trades move against them. While it is possible to use leverage in investing, many investors don’t use a high leverage than traders.
Shorting risks
Day traders buy assets and hope that their prices will rise and short assets they believe will decline. There are several risks to shorting since a stock price has no limit to how high it can go.
It can rise in perpetuity, meaning that you can make infinite losses. We saw this during the meme stock frenzy that happened during the pandemic.
Overtrading risks
There are also overtrading risks, especially when you are using the scalping trading strategy. In this, there is a possibility that you will lose more money by opening numerous trades. This is contrary to what investors do since they open just a few trades in a year.
It is better to focus on fewer profitable trades than to open too many and risk losing control.
Volatility
Day trading has to deal with volatility several times a day. And we know it is not easy to surf through volatility, due to uncertainty in predicting the movement of the stock.
But more volatility means more chances to enter/exit a trade and more chances to profit. For a skilled day trader, this situation is undoubtedly the best for maximizing his profits.
Investing risks
Although long term investing has fewer stresses in the short term, it still has some risks to keep well in mind.
Key macro risks
There are several macro risks that investors face. For example, no matter how good you are, it is impossible to predict what central banks will do. And as we have seen before, actions by central banks have an impact on stocks.
For example, stocks and commodities tend to rally when the Fed embraces a dovish tone and vice versa. Other macro risks are geopolitical risks like wars and trade conflicts.
Related » How to Master Macroeconomic Analysis
Valuation challenge
There are several approaches for valuing companies like DCF and PE multiple comparisons. However, in most cases, finding the real value of a company is often a difficult thing.
In the past, we have seen many highly-valued companies beat those that are not highly valued.
Change of sentiments
At times, there is a general change of sentiment in companies. For example, a company like Beyond Meat did well as investors believed that people will shift away from animal meat.
However, the stock then plunged amid concerns about the industry.
Corporate concerns
At times, there are concerns about companies that are difficult to predict. For example, as shown below, Adani Enterprises shares were doing well for a long time. They then collapsed when the company was accused of impropriety.
Does day trading have more risks than investing?
In most cases, experts believe that day trading has more risks than investing. As we have explained above, the two sides have numerous risks. At the same time, they both have their advantages.
For example, with day trading, you can make money in all market conditions. You can buy stocks when their prices are rising and short them when prices are falling. Traders don’t have a buy or short bias.
Another advantage of day trading is that you can ride the news of the day well. For example, when a stock is rising during the day, you can take advantage of those market movements.
There are other benefits of day trading, including the numerous strategies that are available like copy-trading and algorithmic trading.
Also, day trading allows people to quickly change their strategies when conditions change. For example, if the market moves from trending to range-bound, you should be able to adjust well.
Is day trading riskier in the long-term?
There is no right answer to this question. If you ask someone like Warren Buffett who has a long history of buying and holding stocks well, he will make a case of being a long-term investor. On the other hand, if you ask any of the top day traders, they will make a case for focusing on short-term moves.
Therefore, this situation depends on where you are as a person and your preference. It is possible to make good money as both an investor and a trader.
In our experience at DTTW, we believe that being a day trader is much more profitable since that is what we do. We help traders from around the world create their trading offices.
Summary
In this article, we have looked at some differences between day trading and investing. We have established that day trading is the process of buying and shorting financial assets for generating short-term profits. Investing, on the other hand, involves buying and holding assets for a long time.
It is hard to say which is risky between investing and trading since it depends on personal preference.
External useful resources
Thinking of Day Trading? Know the Risks – Investor.Gov