Day Trading vs Long Term Investing

There are numerous ways to approach stock market to make money. The two most common ones are day trading vs long term investing. Today, I’m going to list out key differences in both the strategies, why people prefer each of them and what’s the risk/reward you can expect. Then finally I’ll talk about my style of investing.

Let’s first understand what these two strategies are: Day Trading vs Long Term Investing.

What is Day Trading?

Day trading also called as Intraday. Means when you buy and sell a share/contract/futures/options on the same day. A day trader do not intend to hold it for long term and hence aims at gaining profit with the short term fluctuations of the security that happens during the day.

Typically a day trader would invest in instruments like currency trading and derivatives markets with the help of technical analysis. They trade in markets like Forex (Foreign Exchange Market) or F&O (Futures and Options) or buying Bank Nifty lots.

I’ve seen many day traders who even take positions which are for less than 1 minute. Which mean they buy and sell the security at the very same minute and take advantage of the small price fluctuation that happens. However, this leads us to the next question. How do they make profits? Let’s understand this with a small example.

A Small Example

Let’s say you’re a gold trader and you have identified that the price of gold is going to increase in next few months. Hence, you’ve got two options: You can either buy the physical gold and store it for next few months then sell it when the price moves up. Or simply purchase a derivative of gold i.e. futures contract. Now you may think why would someone buy the derivative and complicate things?

The simple answer to this is that you’ll not have to bother about storing the gold, worry about it’s security. Buying a derivative can be done online easily without a person’s need to go anywhere. Moreover, when you trade using derivatives, you get leverage. I’ll explain the term leverage in true sense shortly. For now, as an investor, a Futures contract makes your life easy because the price of that derivative will replicate that of the physical gold.

The example I have taken is for a slightly long term approach of a gold investor who invests money for a few months. Here in day trading, the traders are usually looking at executing the trades within the same day or maximum of a week or two.

What is Leverage in Finance?

Leveraging is also called Margin trading. It simply means borrowing someone else’s money (usually borrowed by brokers) and using it to trade. Hence, when the price of a security that you’ve purchased on margin increases, you get more profit and then you can return the borrowed fund with a small fee.

Let’s take another example here: Consider Rocky as a smart investor who knows the price of XYZ share is going to increase today. However, he only have Rs.10,000 saved in the bank account. Let’s say if the share price of XYZ increases by 5%, then Rocky is only going to make a maximum profit of Rs.500 by investing all his savings (5% of 10,000 = 500).

However, let’s assume Rocky had purchased the stock of XYZ at margin. Which means he paid Rs.10,000 as margin and got Rs.90,000 from the stock broker. Which means it’s a margin ratio of 9:1. Obviously, the stock broker isn’t going to give this huge amount to Rocky without any security and expiration date.

So now if the stock price of the same company increased by 5%, Rocky makes a profit of Rs.5,000. Just imagine, the return on amount invested. It’s 50% return on Rs.10,000. This is the benefit of leveraging.

However, on the other side, if the share price of the company falls then the loss will also be magnified and Rocky might even lose all of this savings with just a small fluctuation in the share price.

Long Term Investing

Long term investor also known as Value Investors also invest in the same type of markets. However, the mindset is different. They focus on buying the company instead of buying just a stock. It’s because when you buy a stock, you become a co-owner of the organization.

The primary reason they invest in a company is because they believe that the company is going to make a profit in future and hence want to participate in its long-term success. They focus on the fundamental analysis of the corporation rather than just the technical analysis. It’s because the fundamentals of the company tells the real value (intrinsic value) that someone needs to pay to buy it.

Average duration of any long term investor in a company’s stock would be 10 years or maybe more and it takes a lot of patience to be a value investor as people usually sell the stock in short term by taking small gains.

Key Differences
Image result for trader vs investor
My Approach to Investing

It’s day trading where someone would do speculation on the short term price movement of a security. You’re forced to sell your security (liquidate the position) at a specific time because the leverage always comes with an expiry date. Hence if you’re at a loss, you simply have to book the loss.

Even if you have done complete research based on all the tools, resources and technical charts that you have. There is no guarantee that the price of the company is definitely going to move up within that specified period of time. There are thousands of external and uncontrollable factors that no one can ever predict. If those factors come into play, your margin is gone for a toss.

In long term investing, you’re paying 100% of the stock price up front and you have full freedom to sell the company whenever you want, 5 years, 10 years or keep it forever and just enjoy dividends. That’s what I prefer. I don’t like anyone telling me when to sell.

Hence, even if there is a recession just after you’ve made the purchase, fundamentally strong companies recover and you don’t have anyone sitting on your head to sell it at low price. You might have to wait for longer period, however you’re not worried with the short term hiccups that happens in the market.

In fact, bad days like economic slow-down and recessions give value investors more opportunity as they can buy good companies at a cheap price. When the economy recovers, these fundamentally strong companies are the first to give multibagger returns.

You really don’t need leverage in this world. If you’re smart, you’re going to make a lot of money without borrowing.

Warren Buffet
Conclusion

I personally think day-trading is a type of gambling. Its a scheme for people to get rich quickly. However, in reality, there is no such thing as get rich quickly. It is for people who don’t have enough patience and resilience to hold the stock for long term.

In my experience, I have still not found enough traders who are rich and have anticipated the market turns precisely. However, I can name thousands of long term investors who have become rich by investing in fundamentally strong companies.

Executing numerous trades daily will only increase headache, frustration and you might even just give up from the stock market. I’ve seen people who claims to be value investor but as soon as the stock price moves down for the first time, they sell it immediately. That’s a natural tendency of human, I have done that too in the past. However, it takes special abilities to stay strong when the stock is down.

“Calling someone who trades actively in the stock market an investor is like calling a person who repeatedly engages in one-night stand a romantic.”

Warren Buffett

The only regret I ever have was to sell that company which is now trading at double the price. Hence in the battle of Day Trading vs Long Term Investing, I choose Long Term investing as it’s less risky, more rewarding and sustainable for long term. The power of compounding will, every time work in your favor when you have patience.

“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $1000 and go to a casino.”

Paul Samuelson