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Do you buy and sell stocks with the intention of scoring a quick and easy profit? Or is carefully picking and choosing your investments more of your thing?
Your answers will determine whether you prefer short-term trading, or long-term investing. But which is is best?
In this article we’ll explain the differences between these contrasting investing styles and highlight the pros and cons of each.
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Trading and investing are terms that are sometimes used interchangeably to describe the idea of buying stocks and shares. In reality, however, there are subtle differences.
Trading essentially refers to the act of buying shares with the intention of selling them as soon as they rise above a set price.
Successful trading relies on short-term swings in the stock market. To make a profit, traders must ultimately outsmart the market. This is exactly why trading is essentially a zero-sum game in the way that for one trader to ‘win’, another must lose.
Investing on the other hand, generally refers to the act of buying shares with the intention of holding onto them (a.k.a ‘buy and hold’). With long-term investing, investors aim to profit through rising share prices over time (capital gains), and/or through dividend payments.
Because the stock market generally rises over time, long-term investing shouldn’t be considered a zero-sum game. That’s because all ‘investors’ can ultimately be winners in the long run. Think of it this way… if the economy expands, then the total value of the stock market will likely rise in value without the need for other market participants to suffer. This is why, for example, the value of the FTSE 100 has more than doubled over the past 30 years.
Here at Money Magpie, we often favour the long-term approach, as trying to second-guess the market is tricky to say the least. That said, there’s no doubt that money can be made by short-term trading, so in the balance of fairness, we’re going to explain the pros and cons of each strategy, starting with the benefits of trading…
While trading is sometimes compared to gambling, as we say above, it is possible to make money buying and selling stocks in a short space of time. Here are some benefits of trading…
Perhaps biggest benefit of trading is the opportunity to earn big profits in a short space of time.
With trading, if you manage to pick a winning stock which goes on to soar in value in a matter of minutes, hours, or days, then it’s possible that you could end up with a chunky return on your initial investment.
And while it’s very difficult to spot such ‘winners’, it’s not unheard of for some stocks to skyrocket in value in a short period of time – though this usually applies to stocks that are highly volatile.
Another benefit of trading is the requirement to pick and choose your own stocks.
It is, of course, debate whether deciding which stocks to buy is a real benefit. However, many will consider regular trading as a lot more fun and engaging than sitting back and playing the long game, especially when compared to long-term passive investing.
Thanks to the explosion of mobile investing apps that have flooded the market in recent years, trading is now easier than ever. This means buying and selling stocks in quick succession is arguably the easiest way to invest, especially if you don’t have any long-term financial goals.
With trading, you just need to download an investing app, decide which stock to buy, and… boom! In contrast, long-term investing usually requires a lot more thought!
Now we’ve explains some benefits of buying and selling stocks in quick succession, here are three drawbacks of trading…
Given trading is a zero-sum game, if you buy and sell stocks and want to earn a profit, there’s another trader out there who will have to suffer a loss. When it comes to trading, the term ‘dog eat dog’, comes to mind.
And don’t forget, when you try to beat Mr Market, you aren’t just competing against other retail investors, You’re also competing against hedge funds, supercomputers, professional analysts and the like, so don’t think it’s a level-playing field.
Put simply, beating the market is very hard, and this is why big losses are possible. If you do decide to buy and sell stocks on a hunch, it’s best to start small and keep your expectations realistic.
Besides having to beat the market, traders also have to contend with high fees. That’s because a number of investment platforms will charge ‘share dealing fees’ which is a fee that applies every time you buy or sell stock.
Depending on the platform, this could in the form of a fixed sum, or a percentage of the amount traded. And even if these fees are relatively small in the grand scheme of things, given that your typical trader is likely to buy and sell a lot of shares, these charges can add up quickly which will eat into any profits.
To learn about these fees to a minimum take a look at our article that explains the difference between share dealing fees and platform fees.
Hindsight bias refers to the psychological tendency of individuals to believe that they accurately foresaw an event before it happened. This is very common in the investing world, and can lead to excessive confidence. This is one reason traders may sometimes find themselves taking on unwarranted risk.
Even if you believe you aren’t the type to succumb to hindsight bias, it’s really important to at least be aware of the phenomenon.
Now we’ve explored trading let’s move on to long-term investing, starting with the benefits…
All investing types carry an element of risk, so before you invest, always bear in mind that the value of your investments can fall. That said, long-term investing is less risky than short-term trading. Here’s an example why…
Say you’re a short-term trader and you buy a share which soon plummets in value. In this scenario you may be tempted to quickly offload your stock before things get any worse. After all, having capital tied up while waiting for a stock to recover – if it recovers – is a big no-no for this investing style. To put it another way, traders are more likely to crystallise their losses when the going gets tough, rather than wait it out.
In contrast, astute long-term investors will recognise that the value of their portfolio will experience a few ups and downs. Yet, in the long term, these investors will also understand that the stock market generally heads upwards and which is why long-term investors are less likely to fall into the trap of panic selling.
So, when it comes to minimising risk, long-term investing wins.
As highlighted above, high fees can eat into investing profits, whether you’re a short-term trader, or a long-term investor. However, in general, long-term investing is cheaper than trading because long-term investors don’t make as many transactions.
Not only that, but long-term investors, especially passive investors, may wish to buy a low-cost index tracker fund. This is one of the cheapest ways to invest, and such funds are simply not compatible with short-termers.
Compounding returns refers to the snowball effect of earning money, not just on your initial investment but also on any profits you’ve already gained. This can result in continuous exponential growth.
It almost goes without saying but due to the short-term nature of trading, traders obviously can’t benefit from the magic of compound returns.
No investing style is perfect. Here are some drawbacks of long-term investing…
Ok, we admit it…. investing isn’t as ‘fun as short-term trading – partly because quick and easy profits isn’t really a thing when inventing your capital for the long term.
In short then, the first major drawback of long-term investing is that it won’t make you rich overnight. Long-term investing requires patience and discipline, and doesn’t necessarily require an eye for an undervalued share.
There’s little point investing for the long-term if you don’t have some sort of financial goal in mind. After all, if you invest without a goal, how will you know when to sell your stocks and shares?
Yet unlike trading (where your goal is to make as much money as possible, as fast as possible), putting together a suitable long-term investing strategy takes time and careful planning. If you’re someone who is impatient or lacks a long-term vision, you might consider this a drawback of long-term investing.
Yep. Even though long-term investing is generally less risky than trading, there are no guarantees. All investing types carry an element of risk. So before you invest, always bear in the mind that the value of your investments can fall.
So, in other words, if you choose to go down the long-term investing route, keep in mind that coming out on top isn’t a given.
There’s no right or wrong answer here. Well, actually there is… but it depends on your personal attitude to investing.
If you’re an investor with planned financial goals and you’ve the patience and discipline to build wealth over time, then long-term investing is almost certainly for you.
If, however, you welcome the thought of fast-paced stock picking, and you’ve the emotional energy to cut your losses when necessary, then short-term trading could be for you. Just remember, that trading can be a very easy way to lose money, so never trade more than you can afford to lose.
If you’re new to investing, do take a look at our article that explains how to set your investing strategy in 5 simple steps.
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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. Companies listed above are not necessarily endorsed by Money Magpie. When investing your capital is at risk.