Free time during a pandemic and few options for “play” can lead to all sorts of things — like an increase in day trading. With fintech firms like Robinhood and others, charging little or no commissions, it’s trading time, especially for millennials and stock market newbies trying to cure boredom and make a buck too.
But in all the excitement, what sometimes get lost is the fact that trading is not investing.
“There are big differences between investing and trading. Both want to profit from appreciation in the stock market, but the time horizons are very different,” explains Aviva Pinto, managing director of Wealthspire Advisors in Port Washington.
Investing is long-term, you look at your goals, risk tolerance, liquidity needs and time horizon. “You look to diversify your portfolio appropriately for your circumstances and put money in various asset classes,” she explains. Ideally, you rebalance as markets move and stick to your long-term plan in the face of market volatility.
Trading on the other hand, is often about, “trying to get rich quick,” she says. You watch the market go down and pick out a stock or a number of stocks that you think you can turn quickly. Trading is all about price.
If you’re dabbling or thinking about dabbling with day trading, there’s plenty to know.
Trader vs. investor
Scott Brown, a financial adviser with Raymond James Financial Services in Orlando, explains the modus operandi of a trader. “They’re looking for small inefficiencies in the market. Taking advantage of ‘news’ or ‘information’ which has not yet been disseminated by the market.” He says a trader will sell Ford because he or she believes the market has overestimated how well the new F150 will be received. In comparison, an investor buys Ford no matter the initial reaction to the F-150. “The long-term appeal of the world’s largest selling vehicle will continue, due to Ford’s commitment to hybrid and electric vehicles,” says Brown of an investor’s thinking.
The trader expects to save 50 cents on a $6 dollar stock tomorrow, whereas the investor is making a long term bet the stock will rise to $20 in the next five to 10 years. “Investing has the advantage of time and long-term market appreciation on its side.”
As for trading, Brown says, “Trading is a chip short of gambling and frankly, information that has not been disseminated by the markets is largely a fool’s errand.”
Trading can be tricky
The trouble with trading, explains Joseph Favorito, a managing partner with Landmark Wealth Management in Melville, “is that there really isn’t any highly reliable consistent strategy. It essentially works until it no longer works. If you are trading with a substantial portion of your assets and end up on the wrong side of a trade, you might end up doing catastrophic damage and wiping out a decade or more worth of retirement savings. Unfortunately, I have seen this happen to too many people. In my opinion, it’s just not worth the risk with any sizable amount of savings.”
While the trader’s high when they score a quick profit can be thrilling, trading is not all fun and games. “It is time intensive, and not very easy,” says Dabney Baum, a financial adviser with Baum Wealth Advisors in Boston. After all, day trading requires knowing how to read charts, understanding stock momentum and much more.
Baum warns, too, that capital gains and losses can catch up with both successful and unsuccessful day traders. She has other concerns, “Many may not understand the implications of the trades’ tax consequences. There may also be hidden commissions for option trading or other large transactions, even for speaking to someone.”
There are tax consequences. Day trading is considerably less favorable from a tax standpoint as gains held less than a year are taxed at ordinary income rates compared with long-term capital gains rates, Brown says. Furthermore, day traders can get caught off guard by a hefty bill. This can happen even if you have lost money in your holdings. To get out of it, they end up having to sell some of their stock in order to pay the tax bill, generating another future tax bill, Baum says.
When you’re trading you have to always consider the moment and be precise in your decision making. “Have a plan because every time you are a buyer someone else is a seller and you both can’t be right, says Scott San Emeterio, CEO and founder of BallStreet Trading in Manhattan.
Day trading gets emotional, which is problematic if emotions overrule common sense. San Emeterio says traders need discipline and conviction when entering and exiting the market.
So, are you a trader or an investor?