What’s the difference between stock investing and stock trading?
The biggest difference is time. Investing is long term. Trading is short term. And because of that key distinction, you get several other differences as well.
Which is better? That’s up to you. Do you want:
- Monthly cash flow or appreciation over time?
- High risk / high reward, or slow and steady growth?
- Tax advantages or more active income?
- Exhilarating ups and downs, or never need to look at your account?
Let’s examine both investing and trading and you can decide for yourself which is your preferred flavour.
For real estate investors…
If you invest in real estate, then here’s a quick analogy to help you frame everything.
Stock investing is like owning rentals. Stock trading is like flipping houses.
If you’re a buy and hold real estate investor, then you might like stock investing. It’s the same concept as buying rentals, except you don’t have to manage tenants or maintain properties.
You can buy stock and just let them appreciate. The beautiful thing is, you don’t have to worry as much about “making money in the buy” with stocks.
Although you can still do that (and if we’re being honest, it’s pretty fun), the history of the market points to steady increase in wealth over long periods of time.
Of course, there’s no guaranteeing that the market will always go up. But with patience and some savvy stock analysis, you can make even more money when markets are down.
If you flip houses, then you might like stock trading. You understand the need to buy low and sell high. You respect how important timing the market is.
It’s the same for stocks. The beautiful thing is, you don’t have to renovate stocks. You just need the ability to recognize when a stock is beaten up and will make a comeback.
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Tax differences between stock investing and stock trading
Similar to real estate investing, different forms of investing get different tax treatments. If you sell a rental you’ve held for several years, you’re only subject to capital gains tax.
If you sell a house you flipped in the last 6 months, the profit is taxed as active income.
It’s similar for stocks. If you sell stocks you’ve held for years, you’re only subject to capital gains tax. But if you’re day trading, the CRA could say you’re carrying on a business and classify your trading profits as active income.
Another beautiful thing about stocks are how easy it is to buy them in registered accounts.
You can buy and sell stocks in your TFSA or RRSP and not be subject to any tax on the profits. However, you cannot day trade in registered accounts. If the CRA thinks you’re “carrying on a business” in a registered account, they can still tax you fully.
Difference in risk vs. reward
If you’re trading stocks, you can be in and out of a position within months, weeks, or even within the day.
This means you have to be right about which direction the stock is heading. If you buy, thinking it’s going up, but then it drops for a bit, you may not have as much time for that stock to recover before you want to sell it.
Time is generally not your friend as a trader. However, if you’re right more often than not, the short term gains can be lucrative. You just have to be right alot.
As a stock investor, time is on your side. You can buy and hold for decades and cash out only when you’re ready to retire. Your stocks could dip 20 times, but as long as you hold, they have time to recover.
Of course, stocks don’t always go up, and if it becomes clear that a company is going out of business, or even just out of style, it may be time to sell.
The mentality of investing vs stock trading
The mentality of an investor is summed up by these points:
- Find quality companies that have proven business models and financials
- Buy and hold for decades.
- Don’t look at your account too often. Correct only if something is really wrong.
- Sell when you’re ready.
The mentality of a trader is very different:
- Be able to recognize patterns in how the price moves
- Know your entry and exit points.
- Be willing to take losses and try again, over and over again.
- Take calculated risks on companies who look poised for growth
- Stick to your trading rules. Don’t let emotions rule your trade decisions.
Actually, that last point can be said of both investors and traders. Keeping emotions out of investing is generally good practice, no matter what.
Where do I start with stock investing?
Start in a TFSA or RRSP if you haven’t started buying stocks in those yet. Then:
- Look for companies you trust.
- Learn some essential ratios you can use to compare stocks, like Price to Earnings, Earnings per Share, Debt to Equity, and so on.
- Find companies that have increased their dividend year over year for the longest periods of time. Usually, this means they have a measure of stability that allows them to pay shareholders from their profits. Also, you get dividend payments every quarter from them.
Where do I start with stock trading?
This is trickier to answer.
You need a lot more education to understand how stocks move and how to recognize patterns in their movement.
We would actually recommend learning how to trade stock options first. I know that sounds wild, but the nature of stock options gives you a buffer when entering a position. That means the stock can drop, but as long as you gave it enough buffer and time, you still make money.
You can make just as much, if not more money trading options as you can trading stocks.
But you still need to learn how stock options work and how to recognize price patterns.
If you’re interested in learning more about stock options, check out our Options for Beginners series. By the time you finish that three part series, you’ll have a good idea if stock options are for you or not.
That’s all for now.
Happy trading,
Your fellow Stock Hackers,
🍒Cherry & Erwin
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