Investing and trading are terms that are commonly interchanged by novices in the industry. It’s important to understand, however, that these are two completely different things. Investing is associated with positions of a longer time frame, while trading constitutes positions that are opened and closed within months or even a matter of seconds. The reasons for assuming a position in an asset also vary, with long-term investors looking for value and growth whereas short-term traders rely on technical indicators and data-driven strategies.
Within the realm of trading, you can further subdivide strategies based on exactly how long the positions are held for, two of which are swing and day trading. Both are short-term strategies for buying and selling assets but both are very different in terms of risk and reward. Knowing these subtle differences can help you better pick a technical approach that best suits your profile as a trader.
What Is Day Trading?
Day trading, as the name implies, pertains to the activity of buying and selling a financial asset, such as a stock or commodity, within a single trading day. Although it can be legally and strategically practiced in any financial market, day trading is most commonly performed in stock market exchanges as well as in the foreign exchange market. Day traders are typically well-funded and employ high-leverage trading strategies to take advantage of small price changes that happen throughout the trading day. Because of the highly liquid nature of forex or currencies, it is one of the more ideal marketplaces for day traders to participate in.
What Is Swing Trading?
One of the key differences between day trading and swing trading is holding time. The latter usually requires you to hold a position for more than a day as your anticipated move unfolds. Swing traders attempt to find swings in the price of a financial asset, be it stocks, commodities, or currencies, that are about to occur over the next couple of days or weeks. Swing traders can still choose to buy and to sell a position within a single trading day if their strategies, such as technical analysis or price action, tell them to exit the trade early. More likely, however, swing traders will set their risk and reward targets and leave the position on autopilot to close either with a profit or a loss.
Pros and Cons of Day Trading
These two styles of trading have their own benefits and pitfalls, and neither one has a leg up over the other. Traders should use a trading style that best fits their skill set, available time they can commit to the activity, and preferences.
Pros of day trading:
- Potentially higher ROI – There is the ability to capitalize on multiple profitable opportunities present in any single trading day.
- Adrenaline rush – While traders won’t admit to it because it sounds like what a gambler might claim, accurately predicting where the price of a given asset moves is nothing short of a rush. The more you win, the more frequently you get that sense of euphoria.
- Faster growth with limited capital – With long-term investing, you’ll need to have a larger position to justify missing out on the short-term price changes for the long-term trend. With day trading, you can combine higher trading frequency with broker-offered leverage to magnify potential profits.
- Compatible with more financial assets – With long-term investing that usually involves a longer holding time of a year or more, you’ll need to pick assets that can theoretically keep going up. Investing in currency, for instance, means that you are buying one currency and simultaneously selling another currency. While you can invest in forex for the long haul, it may not be the most suitable asset to hold for an extensive time since one currency won’t be able to continuously outperform the other one.
Cons of day trading:
- Potentially higher risk – Trading more frequently can indeed bring in more profits, but it also means you can lose significantly more than what your account can sustain. Since your positions are held within a single trading day, you are at a higher risk of catching price whipsaws during highly volatile market conditions. If you are over leveraged or if you pick bad stop-loss targets, you can find yourself getting margin calls only for the price to return back to your predicted price direction.
- Minimum capital requirement – To be able to day trade stocks in the U.S., you must maintain a minimum broker account size of $25,000. There are, however, a few loopholes that you can use to still be able to trade even with a smaller account size, such as opening multiple broker accounts in order to get more than the standard three-day trades per rolling five days.
- Higher time commitment – Day trading means you’ll have to manage your positions full time. While it’s indeed possible to set up an automated trading system that buys and sells positions based on a set of parameters, you’ll still need to invest time in checking price patterns, volatility and liquidity conditions, real-time macroeconomic data, and other variables.
Pros and Cons of Swing Trading
Swing trading carries a similar set of pros and cons as that of day trading. However, since swing trades are held for longer durations as opposed to day trades, your volatility risk is lower since you aren’t subject to the wild daily price fluctuations that day traders have to deal with.
Pros of swing trading:
- High returns between 5 to 10%– According to Digital Blogger, this style of trading offers a relatively better short- or medium-term ROI compared to other traditional investing methods.
- Flexible time commitment – Compared to day trading, swing trading doesn’t require you to be constantly looking at candlestick charts and price quotes. You can swing trade while still being able to do your full-time job and personal responsibilities. Once you’ve found a potentially lucrative swing trade, you open a position and simply let it move for the next several days or weeks.
- No minimum capital requirements – Unlike day trading wherein you need a minimum account size of $25,000, swing trading doesn’t have any capital requirements. You can open multiple positions at any given time as long as you hold them for more than a day.
Cons of swing trading:
- Higher taxation rate – Similar to day trading, people living from trading profits will have to set aside a larger sum for their taxes than what long-term investors pay in taxes. The average federal tax rate for long-term investments in 2019 was 15%, which was 9% lower than the tax rate for short-term profits.
- Volatility risk – Although you are less prone to intraday volatility risk, swing trades are still subject to sharp overnight and weekend market movements that can trigger a margin call and, ultimately, result in substantial losses.
Tips for Both Day and Swing Traders
- Do your research – Whether you’re a pattern day trader in tech stocks or a momentum trader in precious metals, you need data to base your trading decisions on. Logic and reasoning are better tools than gut instinct and preference when selecting which assets to trade. Do your homework, and treat trading as an actual business rather than a hobby. Start building watch lists of assets that you want to keep track of, and learn how to interpret financial reports and macroeconomic news releases regarding said assets.
- Avoid penny stocks – Whether you’re employing an intraday system or a swing trading strategy, it’s best to avoid penny stocks when building your portfolio. It’s all too common for inexperienced investors to go for low-cost assets in an attempt to grab a larger position of that particular asset. After all, if you have 1,000 shares of a $1 stock, you can double your investment if that stock climbs to $2. The caveat with penny stocks is that they are often illiquid and have a low probability of climbing in value.
- Cut your losses short – If you are to take anything away from this discussion, it should be this tip. Risk management is what differentiates great traders from bad ones. The ability to cut a losing position quickly might sound theoretically simple, but in the heat of the moment, inexperienced traders choose to hold onto it in the hopes of it bouncing back. Cut your losses short either by manually closing the trade or by setting stop losses that automatically close out your position when it hits a certain price level or dollar loss.
From a strategy and risk point of view, it’s important to stick with the type of trading that makes you the most comfortable. If you are uncomfortable with the wild fluctuations that come with intraday trading, you should look into momentum or swing trading. For those impatient with the day-to-day ups and downs of the market, becoming a day trader and locking in those small, short-term profits may be a better style of trading for you.