What is Day Trading? How Does it Differ From Investing?

Learn why day trading is probably not in your best interest.

By Sam Swenson, CFA, CPA – Updated Sep 6, 2024 at 1:27 PM

Key Points

95% of day traders lose money, indicating high risks in short-term trading strategies.
Long-term, buy-and-hold investing in ETFs increases chances of profit over time.
Day trading incurs high tax rates on short-term gains, reducing overall profits.

People on social media occasionally tout the large profits they collect from big, one-day bets made on speculatively held stocks. For some, this form of trading is tempting. What's better than buying a few hot stocks, waiting an hour or two, and then making more than $100,000? It seems so simple and so easy.

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An infographic outlining the major differences between day trading and investing. — Image source: The Motley Fool.

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The reality is that consistently making money as a day trader is a rare accomplishment. It's not entirely impossible, but it's certainly an imprudent way to invest your hard-earned cash. For people considering day trading for a living, it's important to understand some of the pitfalls.

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Exchange-Traded Fund (ETF)

An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once.

Investors with long-term holdings are well positioned to diversify their investments and mitigate the risk of large losses. Day traders who buy and sell just a few popular stocks have portfolios that are much less diversified, so the movements of any one stock have a much larger effect on their financial health.

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Realized Loss

A realized loss occurs when an investment is sold for less than its purchase price, resulting in an actual financial loss.

A primary reason day trading is a bad idea has to do with transaction costs. The two most visible transaction costs are taxes and fees, such as trading commissions. If you purchase a stock and sell it before one year has passed, then any increase in the stock's value is taxed at your ordinary income tax rate, which is likely significantly higher than the tax rate that would be applied if you held the stock for a year or more. Depending on the trading platform you use and the type of security you're trading, you may also pay a commission every time you buy or sell a stock. These transaction expenses can be costly for day traders.

The inherent nature of the capital markets also typically makes day trading a losing proposition. Minute-to-minute stock price movements on any particular day are little more than random, and they tend to instantaneously adjust to any new publicly available information. Further, when you place a market order to buy or sell, you're trading against a large swath of sophisticated institutional investors and high-frequency trading machines. The probability that you know something professional investors do not -- without it being illegal insider information -- is extremely unlikely.

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Institutional Investor

An institutional investor is a professional organization or company that invests money on other people's behalf. Here's what you need to know about institutional investing.

Given that successful day trading is a rare feat -- and even rarer on a consistent basis -- there are many reasons to stay away from day trading entirely. You worked hard for your money and should avoid putting it in unnecessary peril. Especially when you consider the significantly inflated tax rate assessed on short-term trades (sales of any stocks held for one year or less), it's fair to say that day trading is not worth the risk.

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Ordinary Income

Ordinary income is any income taxed at ordinary income rates.

Generally speaking, this tax rate is higher than the tax rate assessed on long-term capital gains, which are levied only after a stock or other security stays in your portfolio for a year or longer. The considerably higher tax rates applied to short-term capital gains are another reason to consider holding your investments for at least a year.

Aside from its inherent riskiness, day trading is especially not worth it when you factor in the significantly higher tax rates imposed on short-term trades.

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How you invest your money is ultimately up to you

You get to decide how to best deploy your money. If you decide to day trade, then the most prudent approach is to keep the dollar amounts at risk relatively low -- say, no more than 10% of the value of your overall portfolio. That amount might be enough to gain day-trading experience, but it won't completely devastate your portfolio if your short-term positions incur large losses. If you're also considering other strategies to build your net worth, you'd be wise to learn the many benefits of investing for the long term.

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