Since lockdowns started in March 2020, not a single hobby has gone ignored — we’re now expert sourdough makers, world-class knitters, guitar aficionados and more. But there’s another, less labour-intensive activity that many have also picked up: active trading.
In the past two years, countless people across North America have started buying and selling stocks like they’re trading hockey cards — scooping up one company and then getting rid of it soon after, with the hope their shares climb in value. Trading activity increased dramatically in the first quarter of 2020. The Economist reported that retail trading flows — trades made by average investors rather than institutions — increased to 40% of trading volumes in the first quarter of 2021, up from the typical 25%. Trading on the Toronto Stock Exchange surged 158% in February from a year earlier. Most of that growth is from average investors pushing that volume higher.
It’s easy to understand the allure of active trading, a venture that tends to rise in popularity during intense periods of market volatility, when equity prices can significantly rise or fall in value over the course of a day. It mostly involves sitting in front of a computer or a mobile phone and purchasing and selling stocks quickly, with the hopes of making money off those swings. It also takes little effort — especially with the many trading-focused apps that make it easy to jump in and out of stocks — and you can do it from your couch or even while your delicious sourdough masterpiece is rising.
What many people may not realize is that trading and investing both involve stocks and stock markets, but they are two entirely different things. And that can be important to understand: If all you’re doing is trading, you may not be growing the long-term wealth you need to meet your future goals.
Here are just some of the ways that active trading and investing differ.
Gains vs. losses
In many ways, active trading can be akin to poker or blackjack. There can be some strategy to it, and it’s fun, but it can be hard to grow long-term savings from playing these games.
How much traders make may be hard to quantify — as with gambling, people may be more likely to talk about hitting it big, and less about losing large. A 2011 study by the U.S. Securities and Exchange Commission which looked at forex traders — people who trade currency, which can be even more difficult to do than trading stocks — found that, on average, 70% of accounts lose money every quarter and lose 100% of their investment within 12 months.
One way day traders make money is through volume. They’re usually trying to make small gains over and over again — for example, they might buy when a stock is $5 and sell when it’s $6 — with the hopes that all those increases add up. The more shares you buy, the more you’ll make off each $1 increase. It’s a highly risky strategy, because, of course, that stock could just as easily drop by $1, causing an investor to lose big bucks.
When it comes to investing, many people stay in the market for years, and even decades, making it easier to make money. Between 1960 and 2020, the S&P 500, America’s main stock market index, has gained, on average, 7% per year. The S&P/TSX Composite Index has experienced a 9.3% annual rate of return over that same time. While there have certainly been fluctuations in the market during that time, a wider lens would reveal an overall trend of growth.
There is, however, another way investors can make money from small dollar amounts. Not only do markets rise over time, but with compound investing, every gain is based on the gain that came before it. Say you save $100 and then put $25 into the market every month after that for the next 30 years. If that money grows at a 3% annual rate, you will have $14,650 after three decades, even though your actual contributions total $9,075.
Fundamentals vs. speculation
For the most part, active trading is speculative — you’re hoping a hot stock will rise by a few bucks, or maybe you just want to take a chance on something on a whim. Unlike investors, traders may not be interested in business fundamentals such as whether a company is growing its earnings or paying a dividend. For example, they may pay more attention to whether a news event might push a stock higher or lower, while the savvier traders might study mathematical charts with names like “the head and shoulders pattern” or “Fibonacci retracement levels” to predict whether a particular stock might rise or fall in value. Ultimately, traders must be hyper-attentive to every tiny market move. That can be hard to do when you also have a day job.
Long-term investors can have the freedom of being much less attuned to what happens day-to-day, and they’re certainly not going to predict where a stock’s price might be next week. While they do want the companies in their portfolio to grow in value, they can have patience that it may happen over years instead of days. Many people will buy mutual funds or exchange-traded funds, baskets of securities that come with stocks and bonds already chosen, and many who do want to create their own portfolios will do a bit of research. They may look at a company’s fundamentals — its earnings growth, whether sales are increasing, how much debt it’s holding and if the management team has a track record of success — to determine whether or not that company may do better in the future. If they think it will, they might buy it. If not, they’ll leave it alone.
Investment plans vs. trading plans
Here’s another difference between investors and traders: The former usually has some sort of long-term plan that’s rooted in a variety of goals. For instance, a long-term investor might determine that they need $5 million for retirement or $50,000 for a down payment on a house. With that in mind, one can build a portfolio and an investment plan to help get there. The plan could include a number of things: It might outline how much you should save per month, how you should react in a market downturn, what investments should make up the core part of your portfolio, guidelines around diversification and more. This plan keeps people on track and allows them to do things other than pay attention to the market.
Traders have plans, too, but theirs may be entirely different. They may be focused on what they’re going to do today — what stocks they might invest in, at what point they might take profits and when they should cut their losses. These plans are there to help them stay focused on their immediate task, which is to make more money over a short time frame.
Long-term versus short-term growth
There’s no doubt about it — trading can be a lot of fun. If you have a few bucks and you want to see what it’s like to buy and sell something over a short time horizon, it could be something you enjoy. But the good times can end pretty quickly. Research has found that when active traders hit it big, their brains release dopamine, just like those of gamblers do. That can lead to people making bigger bets, taking larger risks and there’s even the potential of addiction.
It stands to reason that investing may offer less of a rush since you might not be paying attention to what your portfolio is doing on a daily basis. Some investors might check in once a month or even once a year to see how you’re doing. The fun comes from regularly saving and knowing that by being patient you’re likely increasing the value of your net worth over time.
All this is to say, the next time you hear about traders running up a stock, you might be right to wonder if they’re really investing. Patience and a long-term approach tend to produce steady results.
