There are two types of people working in the stock market, traders, who always look for stocks that have potential to go up quickly in a short span of time, investors who look for stocks that are backed by strong business models with good past performance and potential to grow multiple times over the years. It is hard to say with certainty, which method is better and makes more money for you.
When you trade in stocks, you commit your capital for a short period of time and book smaller profits. The advantage of trading is that your capital does not stay stuck in one place and you can reuse it to invest elsewhere to make more money.
Investing on the other hand requires long term commitment of capital, but rewards you with compounding returns over long term, which means you get paid just for holding your stocks.
If you watch and follow business channels and stock brokers, you will notice that they always want you to trade stocks instead of investing, and there is a reason behind it. Business channels make money by selling advertisements. Some of the biggest advertisers for these channels are big brokerage houses, that make money by buying and selling shares on your behalf for a commission. The more you buy and sell, the more money they make.
As per my experience, if you want to make some serious money from stock market, trading is not a good option. There are many reasons behind why trading in stocks is not a good option to make money if you are trying to become rich. Some of the strongest reasons are mentioned below:
Its difficult to predict markets in the short term:
In the short term, stock prices are driven by demand and supply factors, which is influenced by peoples perception towards continuous news flow about the company, market trends, expert views and economic conditions and policies of the country. Since there is so much activity and news flow, it is hard to predict which news is important and what impact will it have on the market. This make short term trading more unpredictable which is why it is difficult to make money in trading.
As Benjamin Graham says Stock market is a voting machine in the short term and a weighing machine in the long term. Stock prices, in the long term are driven by the growth potential of the business and difference between the market price and the actual business value. When a business does good stock price appreciate accordingly. It is much easier to predict long term performance of the company, which can be done by looking at the past financial performance of the business and making projections about its performance in the future. For example, if a company has been growing at a rate of 20% for the past many years, even by using conservative estimates, you can say that it will grow at a rate of 15% in the future. Of course these projections may go wrong as they are just estimates, but it is still better than shooting in the dark, and at least you have a number which you can use to track the future performance of the company and its stock price.
When you trade, you work for money:
Trading stocks is almost full time job, when you trade in stocks, you have to take time and effort to find the right opportunity every day. Since there is only limited time and effort you can dedicate in finding these opportunities, there is a limited money you can make by trading stocks. Additionally, you have to keep tracking stock movements on a continuous basis, it requires lot of your time and effort, which is not suitable especially if trading is not your main source of income.
When you invest for long term, you do not have to worry about short term volatility of the market. Long term investors focus on the quality of business, its durable competitive advantage and ability to sustain its market position by keeping competitors away from taking over the business. Businesses with these qualities, grow at a higher rate compared to competitors, which results in above average growth, giving multifold returns to shareholders.
Trading stocks is like killing a golden goose:
You might have heard the story of golden goose, the one that laid golden eggs everyday. One day, the owner got greedy and decided to kill the goose to get all the eggs together. He killed the golden goose only to realize there were no eggs inside her. Because of his greed and short term thinking, he killed a great source of income that could have easily fed him entire life. Trading in stock market is similar to killing a golden goose.
Stocks, like the golden goose, are great cash flow generating assets. Once invested, stocks provides lifetime cash flow in the form of dividends. Companies that do well, distribute dividends regularly to their shareholders throughout their lifetime. There are many companies that are continuously paying dividends regularly for more than 10 years. Many investors invest money in stocks with a sole purpose of earning a dividend income.
When you trade stocks for a short term, you give away a chance of earning lifetime cash flows for a quick profit, losing a great opportunity to earn passive income that you get, just for holding a stock.
You have to pay brokerage on every trade:
Another reason to avoid trading is because it costs a lot. Trading relies on frequent buying and selling of stocks. Every time you buy or sell, you have to pay a percentage of the total money to your broker, who executes this transaction on your behalf and charges a commission for his services. Brokerage has to be paid irrespective of whether you make or lose money, that is why large brokerage houses encourage people to trade in stocks rather than investing for long term. Trading may not guarantee whether you will be rich, what it definitely makes certain is that your broker will be laughing all the way to his bank.
Trading attracts short term capital gains tax:
Expenses of trading are not limited to paying brokerage on every transaction. Short term trading also attracts capital gains tax. When you trade in shares, you have to pay 15% of your profit as capital gains tax. This tax is called short term capital gains tax and is levied when you sell shares in less than one year of buying. On the other hand, if you hold the stock for more than one year (that is 365 days), there is no capital gains tax levied on you. By holding your stocks for more than one year, you can improve your profitability by 15%.
Every disaster is a penalty for a trader, opportunity for an investor:
Traders rely on market trends to place their bets. If the market is going up, they place bets on the assumption that it will continue moving in the same direction. Since trend is a traders friend, they find it hard to stay invested at the time of adversity. When a financial disaster strikes, traders pull out the money from the market, no matter whether they are making profit or losses, and stay sidelined till markets become get back to normal. Unpredictable market corrections are the biggest enemies of a trader, but a great opportunity for an investor.
Investors look for good quality companies trading at a lower price. When disaster strikes the market, all the stocks, irrespective of how good the quality of their underlying business is, gets beaten down, providing great bargain opportunity for investors to buy good stocks at a lower price. Deeper the correction, better the opportunity to buy. In short, while a market correction is a disaster for a trader, it is a great opportunity for an investor.
You have to be consistently right:
Trading is all about finding the right opportunity and making the right move. Since one or two big wins does not mean you are an expert, to keep making money on a consistent basis, a trader has to be consistently right, and that is something which is not always possible. If a trader makes 100 trades in a year, he has to be right either most of the time, or he must be able to find and exploit big market moves. Since markets are highly unpredictable in the short term,?and there is no way to forecast market movements with certainty, being consistently right or be able to ride the big waves is harder than you think.
On the other hand, since investing is always about finding good stocks at a lower price, you can always prepare a list of good stocks and wait for a market correction to jump in. IF timing the market is something youre not really good at, then you can always use the cost averaging method, where you invest a fixed amount of money regularly in a portfolio of stocks and take advantage of market correction by buying more of them at a lower price. ?
There are many reasons trading in stocks does not work for most of the people, you need to give it a lot of your time, which most of us dont have, you have to be constantly vigilant about market news and stay updated about price movements which is again difficult to do. Most traders remain glued to their screens or spend sleepless nights wondering which direction the markets will move and what will be the result of their trades. Investing, on the other hand, focuses on the performance and growth potential of the company and has very little to do with what market says. As long as the company keeps making money, investor, being a part owner of a business keeps earning regular cash flow for a long time, something that a trader can never have, that is freedom.