There are a million ads proclaiming wealth through day trading. The truth is that day traders and long-term investors both make money and lose money. Some successful long-term investors lose their money when attempting to day trade, and some day traders can't pick a good long-term investment. In terms of trading, the difference is mainly in personal temperament and time.
Personal Temperament When Trading
Day trading is based less on fundamental research into companies than on identification of a highly volatile stock – one with many trades and wide price swings in a single day – and hope of making a small profit by catching a swing either up or down. This takes a temperament that is comfortable with risk and a bank account that can sustain losses. A successful day trader follows a trading formula and doesn't deviate. Panic and wishful thinking are the enemies of the day trader.
Long-term investing, on the other hand, is traditionally a research-heavy way to invest. It entails analyzing the financial performance of many companies, as well as their technical price performance, and choosing the ones that appear to have the best growth potential. A long-term investor buys to hold a stock for at least a year and must be confident of the stock's ultimate value to be able to tolerate interim periods of both low and high stock prices.
Trading Time Commitment
Day trading is time-consuming. Some day traders make hundreds of trades during a market session, and although many use limit orders and other tools to hit their numbers, they are still bound to the computer during trading hours. Long-term investors spend time researching, but when they buy their positions, they normally only check their stock once a day and watch for company news. A long-term investor also might add to a position if the stock declines, but micromanaging a long-term investment is essentially day trading.
Level of Risk
In day trading, investors buy stock long and sell stock short. If a stock price moves in the opposite direction from that anticipated by the trader, it must be sold or the short position covered. This means a day trader takes losses as well as profits during a day's trading. To maximize profits on small price movements, a day trader often leverages money by trading on margin; the quick in-and-out combined with the greater loss possible through use of margin make day trading particularly risky.
A long-term investor traditionally does not use margin or sell stock short. The risk of long-term investing lies in failing to make good investment decisions, unexpected deterioration of the company's fundamentals and unexpected market weakness.
Costs and Taxes
Day trading racks up high transaction costs even with low online trading fees. If you make 20 trades a day – 10 buys and 10 sells – at $10 per trade in transaction costs, your day's profits must be at least $200 to break even. The short-term nature of the losses and profits also means the income from day trading is taxed at a less advantageous rate than long-term investing.
However, if you qualify as a trader according to IRS rules, you might be able to deduct the costs of research and computer programs against your tax liability. If you day trade, check with your accountant about the current requirements you must meet.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.