I understand why being a day trader sounds sexy.
No office, no 9 to 5 job, no more yelling bosses, and no commute. Beat the market with nothing but your wits.
And all the EASY money.
Right?
I’ve been tempted to try day trading too. Then I did my research and it turns out that day trading is one of the most difficult ways to earn a living. The odds of making money through day trading are lower than those of winning by gambling at a casino.
What is Day Trading
Day Trading, by definition, is buying and selling stocks on the same day.
In day trading, you try to make a profit from the changes in prices of stocks over the course of the trading day. You could stay in the trade for a few hours, minutes, or even a few seconds. But you exit the position you take during that day.
As a day trader, you’ll be moving in and out of positions all day long.
This is the complete opposite of a buy-and-hold investor who buys a stock, holds onto it for a decade, then sells. This is a long-term approach to investments.
Day traders care about making money right now.
Just like stocks, you can day-trade commodities, currencies, ETFs, cryptocurrencies, and other assets.
Most People Fail Miserably at Day Trading
A study conducted for a fourteen-year period found that less than 1% of day traders consistently make a profit.
You read that right. Not even 1% of day traders are successful.
According to the same research, you have higher chances of making money by playing roulette at a casino.
Day trading seems simple. You sit around all day, enter a trade for a few minutes and make lots of money from it.
While the actual trade lasts for a short time, the analysis behind making that trade takes the entire day. It’s not surprising that all successful day traders treat it like a full-time job.
As a thumb rule, the odds of succeeding with investment increase with time. Investing in the stock market for one year might lose money. Investing over a 30 year period virtually guarantees that you’ll make a healthy return.
Investing over hours or days is even worse. In the short term, prices can get really choppy for all sorts of crazy reasons. Much of it is completely random. Day traders have to deal with this uncertainty. That’s why most people who try out day trading fail miserably at it.
You also have to remember that trading stocks is probably the only field in the world where you are competing with the BEST PLAYERS right from Day 1. Just imagine how much time and effort the top 1% have put in to reach that level and compare it against your expertise and knowledge when you are starting.
Think about what would happen if you are in a tennis match against Roger Federer when you only play at your local tennis club on weekends. The odds are not in your favor.
The Risks of Day Trading
Apart from the random fluctuations in the stock price in the short term, day traders have to handle other risks.
1. Costs and Taxes
When you’re day trading, you will enter and exit positions every day. In the past, you had to pay a fee for every trade that ate directly into your profits. This has begiun to change, mange brokerages now offer free trades. But you still have to pay taxes every time you sell at profit.
While the capital gains tax isn’t as high as normal income tax, it seriously drags down the profits of day trading. Not only do long-term investors pay a lower rate for holding an investment for at least a year, they won’t have to pay taxes on their appreciation for years, maybe even decades. That’s a lot more time for compounding growth to work its magic.
2. Stress
Day trading is a risky business. Stock prices move fast. Your profits and losses will increase and decrease quickly.
If you’re on the right side of the trade and making a profit, you will start to wonder when you should exit. If you’re in a losing trade, your stress levels go upon seeing the mounting losses.
By seeing the value of your portfolio change every second,you’ll be on edge every second of the work day.
3. Large Losses and Large Profits
If you use leverage or borrowed money to enter a trade, your profits and losses are magnified.
A few bad bets can drain out your account before you know it. Taxes and costs add up too. So even when you make a profit, the amount you can actually take home is far less than you expected.
Even if you win, it can lead to your future downfall.
Let’s say you start day trading and make a huge profit. You’ll think that you “cracked day trading” and can repeat the success. So you day-trade again. Then the losses kick in. But you know what winning feels like and assume the losses are bad luck. Then you go deeper. Before you know it, you’re completely out of cash.
The exact same thing happens to gamblers. Many compulsive gamblers had a major win early in their careers and they spend their entire life chasing that one win. They end up losing far more than they won in the first place.
How NOT to Get Sucked Into Day Trading
Day trading is extremely appealing because people believe it is an easy way to make money.
But ALWAYS remember the odds of success in day trading. LESS than 1% succeed.
Gambling can be a ton of fun. It can also be enjoyed responsibly.
Day trading can be approached the exact same way.
I never walk into a casino expecting to make money. I have a maximum amount of money that I can spend that evening. It’s for entertainment and I’m going to live it up. Once I’m out, I’m out. I pack it in and go back to my hotel room.
There’s a few key critical pieces of my mindset when gambling:
- I treat it as an expense, not an investment. I never expect to make money from it.
- I cap my losses. This limits the expense to a level that I can live with.
- My only goal is to have fun. This makes the whole experience better since I’m not stressing about anything. The casino gets my money, I get a great night of fun, it’s a fair trade.
I treat day trading the same way. It’s entertainment and I don’t expect to make money. As long as you cap your losses and stop day trading once you hit that limit, it can be done responsibly.
A common rule for speculative investments is to only put 10% of your portfolio at risk. As long as you’re not taking heavy losses regularly, this works really well. Even if you lose the whole 10%, nothing will change about your financial future. Just make sure not to keep taking another 10% after losing it several times. Before you know it, you’ll be down 50%, or more, in total.
How to Tell if You Are Special and Should Try Day Trading
There’s still a chance that you are special and can consistently make money through day trading.
You would be wondering…how do I find out if I should day trade?
Before jumping in, go through these steps:
1. Trading System
It all starts with a trading system. All the successful traders have one.
Think of a trading system like a guide that tells you when you should enter and exit a trade based on your logical reasoning. It’s like counting cards in blackjack, the system tells you when to bet and when to hold.
If you don’t have a system, you’re basically entering and exiting trades randomly. While you may make some profit using this strategy, it’ll be based purely from luck. That won’t be sustainable.
Apart from entry and exit points, a trading system should also have an effective money management plan (a fancy word for how much money you would risk for every trade).
2. Back Test Your System
The beauty of backtesting your system is you’ll see how it would have performed over a period of time without having risked any money. You can backtest a system manually or use special websites/software meant to backtest trading systems.
If your backtest shows profitability for 10 years, then you have a chance. I recommend going back further and testing your system in a range of market environments. If you only tested 2010-2020, your entire system would depend on a bull market with really low interest rates. Test multiple recessions, bull markets, high inflation/low inflation, high interest rates/low interest rates, and so forth.
Don’t forget to factor in costs and taxes while backtesting as they can eat up your profit.
Lastly, try to account for your own psychology. Everything can look beautiful and logical in a spreadsheet but living the trades day-to-day is a completely different experience. Few people have the stomach to follow their system perfectly, especially through hard times.
3. Trading Psychology
Each person has a different trading mindset. Psychology is a critical aspect of day trading.
In fact, I believe your psychology is 90% of the game. The rest is your system.
If your profitable trading strategy doesn’t match your psychology, it simply will not work in the long run.
Let’s say that according to your trading strategy, you stay an average of four hours in a trade every day. But you are the kind of person who starts worrying only a few seconds into the trade if you start incurring a loss. In such a situation, you panic and hastily exit the trade even if your system has not asked you to exit.
When your system doesn’t match your psychology, you would not be able to follow your system. Which means you are randomly entering and exiting trades. In turn, that leads to losses.
This is why I prefer long-term buy and hold strategies. Once I buy something, I have zero problems holding onto it forever. So I buy extremely carefully and assume that I’ll never sell.
You only have a successful trading system when your trading system matches your personality.
4. Live Market Test
Once you have a successful trading system in place, try it out and test it in the live market.
Even if you have backtested, putting your hard-earned money in a trade is an entirely different game.
Here are some issues that may come up when you take your system to the market:
- All your emotions will go CRAZY. It’s tough to keep them in check when real money is involved. They may hamper your ability to accurately carry out your trading system.
- You may also face practical problems like not being able to buy/sell at the price you want.
- There will be slippages, which may increase/reduce your profits.
- At times, your order may get partially fulfilled or remain unfulfilled.
If you’ve cleared all the points above and are consistently making a profit, then you know you are special. You are among the top 1%. In that case, you can go ahead and try day trading.
Alternatives to Day Trading
If you want to invest in stocks, the best way is to buy index funds.
By picking a lazy portfolio of a few index funds, investing consistently every month, and never selling, you’ll reap these rewards:
- The lowest fees in the industry, maximizing your profit.
- Better overall returns than anyone trying to do it themselves.
- Zero stress and effort. You’ll make a ton of money and never even have to check your account.
- Even in a taxable brokerage account, the taxes are really low compared to other strategies.
- It’s simple enough that you can get the whole thing in place within one afternoon.
More money, less stress, and simple enough for anyone to do it.
This is what I do. And I recommend you take this approach with at least 90% of your portfolio.
Only day trade if you’re comfortable swimming with sharks.
Here’s Our Take on Day Trading in 2020 is a post from: I Will Teach You To Be Rich.
Via Finance http://www.rssmix.com/
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