Day Trading = Financial Suicide?

One method of making money in the stock market is day trading. Day trading rose in popularity in the late 1990s when investors could double or even triple their gains within a matter of hours. With returns like this, it was hard to resist the temptation of becoming a day trader yourself.

In this day and age, you do not get the returns that you could have gotten in the 90s, but the temptation to day trade is still there. Markets have been booming ever since the Great Recession. Since the market bottomed out in 2009, the S&P 500 has returned 172% and the Dow Jones Industrial Average has returned 131%. Due to the increase in markets at such a rapid rate, investors today have been able to day trade and achieve solid results.

As a matter of fact, I just recently read an article on a 16 year old who began day trading and had thus far achieved decent results. In 2012 her stocks returned over 34% vs the S&P 500 which only returned 12%. While it is not impossible to achieve those results, it is hard to maintain such rapid rate over a long sustainable time period.

Jason Zweig discussed the topic of day trading in his commentary to The Intelligent Investor. He discussed that while some trades make money and some trades lose money, your broker will always make money. In addition, he goes into detail about the true cost of trading over such short time periods.

The Costs of Day Trading

  1. Your own eagerness to buy and sell stock will lower your return. Zweig call this cost “market impact.” While this cost doesn’t show up on any of your statements, it can cause you great losses. Let’s say you are eager to buy a stock, and you end up paying an extra 10 cents per share to get it. If you buy 500 shares of that stock, you just cost yourself $50. On the flipside, if you sell the stock too soon, you can also lose out on significant gains.
  2. Brokerage fees eat into gains. Many brokers will charge you anywhere from $4 to $9 to make a trade, no matter how many stocks you purchase. Assuming you pay $7 per trade, you will pay a total of $14 to buy and subsequently sell a stock. If you purchase $1000 worth of stock, this will eat into 1.4% of any gains you make.
  3. Taxes, taxes, taxes. When you buy and sell your stocks frequently, taxes can eat into your gains significantly. Any gains you make on stocks you sold within a year are taxed at your ordinary income rate, which could be up to 39.6%. Compare that to the maximum rate of 20% you pay for gains for stocks held on to for over a year, and you could be paying significantly more in taxes.

Research Study

Zweig also cites a study done by professors of Finance Brad Barber and Terrance Oden at the University of California. In this study, the professors studied 66,465 households with accounts at large discount brokers from 1991 to 1996. What they found was those that traded the most (portfolio turnover of 21.5% a month) had an average return of 11.4% vs a return of 18.7% for those who had the lowest turnover (portfolio turnover of 0.19% a month). In addition, those who had the lowest turnover actually had a slightly better return than the market average. The chart below shows a visual representation of this study.

Image

Questions/Comments?

Have you ever day traded? What are your experience with day trading? Please leave a comment below. I’m interested to hear your opinion. 

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7 thoughts on “Day Trading = Financial Suicide?

  1. Day Trader here –

    No doubt many people lose money day trading, but it’s not due to day trading not being possible or prudent, but rather lack of proper procedure and discipline. There are many folks who lose money the old fashioned way of “buy and hold”, but for some reason the media doesn’t focus as much on those folks as they do more frequent traders.

    The media has issued a set of “caveats” against day trading, some of which you’ve mentioned, that can be easily dismissed:

    For your “costs” of day trading-

    1) There should be no “eagerness” to act in day trading – it’s all about properly timing market entries and exits. One is entering at a planned price with a known profit target as well as a stop loss exit cut off. Stocks can fluctuate quite a bit during the day or week- and that presents an opportunity for the active trader. If a stock moves several point in one direction, and then back again, the buy/hold investor makes no gain while the active investor had an opportunity to lock in profits from that move.

    2) Brokerage fees eating into gains is negligible when with the right broker. Brokers can charge as little as $1 for trades up to 200 shares at a time. So if one buys 100 shares, all one needs to get is a 2 cent gain to cover costs.

    3) Taxes are often mentioned as the “boogeyman” of active trading, but having to pay taxes means one is making profits- which is a good thing. A day trader who makes $30K in profits, which is taxable compared to someone who didn’t trade and make anything and pays no tax is worse off and should feel bad? =)

    Next, if one trades in the futures market, you have built in tax breaks such as 60% of your gains are taxed at long term gains rates that includes day trading.

    You may be shocked to learn that the risk level of a good day/swing trader is much lower than those who just remain in the market, because being in the market is equivalent to risk- and the longer one stays in the market the more risk one embraces. Just ask all those who stayed in the market during 2008/2009 and saw their accounts shrink by more than 40%. Day traders had no fear of overnight market plunges. Sure the market bounced back due to the Fed magic of QE, but one can never be sure of future returns so the folks who let their accounts fall by that amount are truly the reckless ones not paying heed to risk.

    Successful day trading requires skill and effort, but many think it’s a ticket to quick and easy wealth. Like most things in this word, what you get out is directly related to how much effort one puts in.

    The average person shouldn’t day trade without putting in the necessary time in research and training- but for those that do, the pay off can be far superior returns than the index averages.

  2. Thanks for the comment. You provided a lot of insight that I did not know before. I definitely agree with your comment that the average person shouldn’t day trade without putting in the necessary time and research. I will also say that many people in general should not be pick their own stocks utilizing the “buy and hold” method either. Many people are not skilled when it comes to either method, due to the fact that they do not put in the necessary time and effort needed to make money off the stock market.

    I did have a couple of questions that I wanted to ask you about day trading:

    How long have you been trading?
    What resources do you use information on day trading? Do you use any books or websites or are your strategies self discovered?
    What are typical returns of skilled day traders? I would expect this number to vary greatly from person to person, I’m just curious what the average return is for those who have done it over a longer period of time.

    Once again, thanks for the comment. I reading different viewpoints from others out there.

    • That’s true- an unskilled buy and hold stock picker is no better or than a novice day trader. The damage shows up first in a day trader account due to increased activity while the buy/hold losses happen on a slower time frame.

      I’ve been “trading” for several years on a part time basis, but have switched to a full time basis only during that last few years. Only once I went full time did I discover how little I actually knew about real day trading as opposed to market “dabbling” trading part time. Going full time was when the real training started.

      Having no mentor, I did the next best thing and read many book written by day traders. Some are definitely better than others, but none had any “holy grail” info on day trading success. I also perused other trading websites. Taken in cumulative, they provided varied perspectives and tips. My strategies have been self developed.

      There are no “typical” returns when it comes to skilled traders. This is one area where it’s a true meritocracy where the better one’s trading skills are, the more one can earn. A blogger who ran a trading office posted the returns of the best and worst traders there:

      http://dinosaurtrader.blogspot.com/

      He no longer updates, but the returns of the top traders are extraordinary.

  3. Thanks for the info. It is interesting to see different approaches to the stock market. If anyone were to consider become a day or swing trader, I would recommend a very similar approach to your own: read books and blogs, practice on a stock simulator and tweak your strategy, and then start using your own money. By taking this approach, a person could really see if they have the ability and patience to become a day trader.

    I know personally I am not comfortable with the strategies of extremely short-term investing, but I really do find the topic interesting and I feel like I’ve learned quite a bit about day trading in general. Thanks again for the comment!

  4. When markets are swinging rapidly , the chances of retaining profits are more in Day trading . If daily movements are very small in a market say less than an average of 2 % , the best a day trader can make is 2 % .Even for the expert day trader will be left with very less, major part eaten away by the broker , taken in to account of 1.4% brokerage . . Even one with 75 % strike rate at its best will be left with no profit . Brokers of course will be happy as one plays more n more daily .
    In India , most of the retail investors left the market after indulging in day trading and gaining nothing when markets move in their favor and heavy losses when it goes against them . Ultimately , now markets are left with very few retail investors

  5. Normally I don’t read article on blogs, but I would like to say that this write-up very forced me to try and do so! Your writing style has been amazed me. Thanks, very nice post.

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