On the surface of things, day trading and investing might both seem like viable ways of trading with the aim of building long run savings, but they’re as different as can be. Day trading is fast-paced, with quick decisions, and relies on short-term fluctuations in the daily price. Professional day traders may potentially trade hundreds of times within the space of a day.
Long-term investing, on the other hand, takes a slower, more considered approach and should hold investments for months and years, not minutes and days. This buy-and-hold approach uses a completely different investment outlook, by ignoring daily swings and instead focusing on the monthly or annual expected performance of those assets.
A common differentiating term you may hear around this is investing vs speculating, with the main difference being the level of risk that’s accepted with each transaction. While investors will do research and take calculated longer-term risks with the expectation of making a profit, speculators may take a large risk on a company or organisation that has a high probability of failure. But, if a speculator’s risk pays off, then it can provide abnormally high returns – high risk for high reward.
So, is speculating like gambling?
Yes, and no. With gambling, you take a risk with your money based on the odds of your favoured outcome happening, with the hope that the bet goes your way and you make a profit. With gambling, the higher the odds, the more risk you take. Speculating is similar, but without educated decisions on each trade.
With long-run investing, the pace can be slower, and the wins often take longer to show. Gambling and speculating, however, can both produce thrilling results and gut-wrenching losses. The high emotion could appeal to some investors, especially aggressive gamblers. But trades should be made skilfully, after research, rather than based on sheer gut-feel or luck.
Professional vs individuals
It’s important to categorise the difference between professionals and individuals, both in investing and day trading. Generally speaking, professionals are highly trained and will have all the tools, knowledge, and information available to make tactical thought-out decisions. They’ll also generally be paid by a firm. They won’t typically be investing their own money – reducing their risk.
Individuals, on the other hand, are usually people who want to invest or day trade using their own money – which can ramp up the risk significantly. Often, if they’ve chosen to take this route, they’ll understand stocks and the market, but may lack the technical experience or sophisticated tools that the professionals wield.
Why has day trading risen in popularity in 2020?
We’ve seen day trading surge in popularity in 2020. While each individual’s reasons may be slightly different, it’s been a perfect storm of situations that have bolstered this status. For a start, a large percentage of the workforce is furloughed, with many looking for ways to increase their income. Plus, they now have time on their side from when they would have been working and a lack of sports events which they may have previously bet on. Throw commission-free trading offers into the mix and couple that with the strong market results in April and May,[1][2] and many people have taken to day trading as a way to try and profit as they pass the time.
It’s also worth noting that in terms of regulation, anyone can become a day trader or an investor – opening an account is very straightforward. However, the investment amounts can differ greatly. Where, with long-run investing you can buy a portion of a fund (which is a package of lots of different investments) from as little as a £1, to be a day trader working the US stock market, you’ll need a minimum account balance of at least $25,000 (which is around £20,000)[3] making it unaffordable for many.
Some Day Trading platforms offer no-minimum account balance, allowing more people to access this market, however due to the frequency of trades that take place, and the fees associated with each purchase, doing it on a small budget is extremely difficult.
Has this influx of day traders impacted the market?
The honest answer is that it’s not as clear-cut as that. For example, a recent study from Barclays found that day traders using the popular app Robinhood haven’t helped the market to improve in the long term, and their top investment choices have delivered lower returns.[4] In short, that means that Barclays believe there’s no clear relationship in the surge of popularity and the performance of the stock market.
On the other side of the scale, many new day traders are investing heavily in companies that are very risky – something most long-term investors typically avoid unless they are highly experienced with this area. For example, looking at data in Robintrack, which provides an hourly update of what Robinhood users are doing, we can see just days after car rental company Hertz declared bankruptcy, there was a record surge with more than 170,000 users holding their stock at its peak.[5] For comparison, that’s more users than they currently have invested in Netflix[6]. It’s a surge in demand of 577% with the amount of stock bought increasing to an average of 197million shares a day in June – 60 times more than what they typically saw throughout 2019. [6]
But this isn’t just isolated to Hertz, as Chesapeake Energy, and Whiting Petroleum have both had similar stories shortly after declaring or preparing to file for bankruptcy. With the US Federal Reserve’s quantitative easing measures in place, coupled with bankruptcy protection laws, many companies currently have some level of shielding during this pandemic, and the result of this is disrupting one of the stock market’s pricing mechanisms.
As we mentioned earlier, day traders don’t hold stock for long periods – they will typically make all their trades within a single day. This allows them not to stay glued to their screen overnight. But according to data, 37% of Hertz stock, that available to trade, is currently held by day traders[7] which means there are still big, institutional investors who are also involved – for example, BlackRock, one of the world’s largest asset managers with more than 7.4 trillion under management, have been recently active within Hertz stock. [8]
And, while we’ve seen large trading volumes in, there are notable waves out as well – many possibly being influenced by what social media traders are doing. This means that large interest for a specific stock mentioned on social media can artificially alter the price.
The cost and success rates
With day trading, we mentioned the high frequency of trading, but we didn’t mention the high cost per trade. Some trading platforms charge a fee for each trade – often per unit – which can add up when day traders carry out multiple trades per day. For example, imagine the fee is £1 and the day trader carries out 15 trades – that’s £15 a day on fees, in a week that’s £75, which means that you’d be paying nearly £4,000 a year on fees alone. But even with fee-free options, there are still taxes and fees you’ll need to pay – for example, the FINRA Trading Activity Fee (TAF) which is a regulatory fee charged at $0.0001119 per share for each sale with a maximum of $5.95 per trade, while this is a US tax many of the Day Trading platforms are US based so this charge may be included.[9] Long term investing, on the other hand, makes far fewer trades and therefore you typically pay lower fees overall.
But, you may be thinking, if day trading is a higher risk for a higher reward, then will your money grow faster? Well, that all depends on how successful you are when you’re trading, but it’s widely accepted that losing money day trading is easy to do. There have been studies that show individuals who traded actively and speculatively without diversified portfolios typically lost money over time.[10] And, that’s not the only study suggesting that day trading isn’t for everyone, a recent Brazilian study was quoted as “it is virtually impossible for individuals to day trade for a living.”
Those who invest for the long run, however, have much more potential for long-term returns and also capital preservation. For example, if you invested in a fund that tracks the FTSE 100 for any ten years between 1986 and December 2019, you’d have had an 89% chance of making a gain. [11] Granted, ten years is a lot longer than 10 hours, but we’ve all heard the story of the tortoise and the hare – sometimes it pays to be patient and just keep going.
- https://www.wealthify.com/blog/wealthify-performance-april-2020
- https://www.wealthify.com/blog/wealthify-performance-may-2020
- https://www.sec.gov/fast-answers/answerspatterndaytraderhtm.html
- https://www.gamblingcommission.gov.uk/news-action-and-statistics/Statistics-and-research/Covid-19-research/Covid-19-and-its-impact-on-gambling-%E2%80%93-what-we-know-so-far.aspx
- https://markets.businessinsider.com/news/stocks/robinhood-traders-not-behind-reason-markets-recent-rally-barclays-says-2020-6-1029304812
- https://robintrack.net/symbol/HTZ
- https://robintrack.net/symbol/NFLX
- Data from Bloomberg
- http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=4694
- 10.https://faculty.haas.berkeley.edu/odean/Papers%20current%20versions/behavior%20of%20individual%20investors.pdf
- 1 Data from Bloomberg
With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.
Please remember that past performance is not a reliable indicator of your future results.
