I was perusing #investing on Twitter the other day and came across an interesting question. What’s the difference between stock investing and trading? Based on the discussions I saw on Twitter, many people are confused by the two terms. For example, some people argue that stock investing and trading are essentially the same because they both fundamentally involve:
- Buying and selling of stocks over time to make a profit.
But to me, this is like saying that a hippopotamus and a lizard are the same animal because they both have two eyes and four legs. While that’s a true statement, most kindergartners would find this idea hilariously wrong because it ignores important differences.
To understand the important differences between investing and trading we need some working definitions of both terms. I cobbled together these definitions from Investopedia:
- Trading – Profits are generated over relatively short periods measured in hours or days by buying at a lower price and selling at a higher price¹. Usually, the risks associated with each transaction are relatively high. According to Investopedia, the goal of trading is to generate returns that outperform longer-term investing.
- Investing – Profits are generated over relatively long holding periods measured in years and come from both price changes and dividends. Usually, the risks associated with each transaction are relatively low. And presumably, investors aren’t trying to outperform traders.
These definitions show that both investors and traders are types of animals, but they’re different species with distinct characteristics. As I often point out, the four cornerstones of mindful investing (empiricism, patience, humility, and rationality) can help illuminate sometimes subtle distinctions. I’ve already written many posts at Mindfully Investing that apply the four cornerstones to the concept of investing. So, let’s apply them to trading.
Empirical Evidence on Trading
For stock investing, I’ve presented data showing that if you buy and hold low-cost index funds for 10 years, you have more than an 88% chance of making money. It’s much harder to find similar statistics for trading, but here are some fairly reliable statistics on trading “success rates”:
- Long-time trader, Cory Mitchell, indicates based on his observations from 2005 to 2015 that between 3.5% to 4.5% of traders are profitable for “several years”.²
- Mitchell further estimates a 20% success rate for the relatively few traders who stick with it for more than a year and learn from their many mistakes (losing money) along the way.
- A 2004 paper by Barber et al. studied day-trading in Taiwan and found that only 20% of traders made money over a typical six-month period.
- A 1999 report by the North American Securities Administrators Association found that “only 11.5% of the accounts reviewed evidenced the ability to conduct profitable short-term trading.”
So, the most optimistic estimates for successful trading are no greater than 20%, which means your specific odds could be much lower. Mitchell emphasizes that success comes to the most diligent, consistent, and persistent traders that have a willingness to accept and learn from years of mistakes. In other words, it takes a lot of hard work to be successful at trading. Compare this to the simplicity of buy-and-hold investing in stocks for 10-years, which gives you easy access to an 88% percent chance of success.
I’ve noted before that long-term investing can be emotionally difficult, but it requires almost no daily work effort. This is why the best long-term investors are the ones who forgot they even invested in the first place³. In contrast, experienced traders emphasize the extraordinary difficulties of successful trading both in terms of emotional challenges and work effort.
The Patient View of Trading
Approaching investing with patience provides us with a greater capacity to avoid poorly conceived or hasty decisions. Patience also allows us to hold on to our stocks long enough to reap solid returns even though the market might plummet substantially once or twice along the way. In contrast, chronic impatience seems like an entirely suitable mindset for trading. Trading undoubtedly requires some micro-patience, but it need only be applied for a few hours or days at most.
Further, I’d argue that trading mostly appeals to impatient newcomers who are looking for some way to make money fast. That same North American Securities Administrators Association study I noted above concluded that many trading firms survived by attracting new traders through deceptive marketing, unregistered investment adviser activity, and questionable loan practices, among other problematic enticements. In other words, trading firms have been caught selling get-rich-quick schemes to naive and impatient chumps. The study notes that “70% of public traders will not only lose, but will almost certainly lose everything they invest.”
That study was issued in 1999, but today it’s still easy to find online articles enticing readers to start trading stocks as a way to make fast money. Given the empirical data we’ve seen, the idea that trading offers an easy way to make fast money is some of the biggest fake news out there. The real news is that most people can learn the patience needed to really make money in the stock market through long-term buy-and-hold investing.
Trading and Humility
Approaching investing with humility gives us a better viewpoint from which to identify potentially delusional decisions. The definition at the top of this post says that the goal of trading is to generate returns that outperform longer-term investing. That should be an immediate red flag for regular Mindfully Investing readers, who know there’s virtually no evidence that even the most expert investors can regularly “beat the market”. And by definition, buying and selling stocks over short periods constitutes “market timing”, an activity which is mathematically prone to failure.
The whole concept of trading is founded on arrogance instead of humility. The trader assumes that they somehow have the unique skills to be successful where almost everyone else has failed. Or their arrogance prevents them from conducting even the most simplistic research on the difficulties of trading. Cory Mitchell makes a point to say that, in his experience, almost everyone who starts trading secretly assumes they can do it better than everybody else. He makes it clear that more than 95% of the newcomers to trading quickly lose their arrogance, along with most of their money. The other 5% learn the humble lesson that the only way to make money trading is through long, hard, and emotionally challenging labor. More importantly, it’s much easier to humbly reap your share of the market return by investing in low-cost index funds over the long term.
Rational Conclusions
It should be abundantly clear at this point that trading is a completely unmindful distant relative to investing. With mindful investing, you should expect to make money over the long term. With trading, you should expect to lose money quickly.
If the mindful investor is a patient and humble hippopotamus, then the trader is something like a venomous Gila monster.4 If you don’t know what that is, here’s a picture of that strange lizard.
Trading is just plain ugly and toxic.
1 – Or conversely, a trader can profit from falling prices using a procedure known as “short selling”, which I won’t detail here.
2 – Based on anecdotal evidence, Mitchell speculates that the success rate for women traders (as opposed to all traders) is more like 40%. But given the relative rarity of women traders, I’m skeptical that he’s collected enough anecdotes to support this optimistic claim.
3 – Some people claim that the study underpinning this idea is apocryphal. However, it was seriously discussed by Barry Ritholtz and James O’Shaughnessy in a 2014 podcast. Because these two professional investors have provided consistently reliable investing information for many years, I would tend to believe the study was real.
4 – As a longtime amateur naturalist I have to note that hippos are pretty dangerous creatures, reportedly killing 500 people per year, while the last known death from a Gila monster was in 1915. Given that even long-term mindful investing involves some risks, the hippo seems like an appropriate mascot for investing. In contrast, venomous reptiles (mostly snakes) account for 50,000 deaths per year making the Gila monster a decent mascot for trading.
