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Day Trading:
Takes Lots of Time

Trading vs Investing...
Investing and trading are different activities. Investing is typically associated with long-term holding periods with a goal of growing wealth over time for use in the future. Trading usually involves shorter holding periods with the goal of generating immediate gains for use as income. Though short-term trading times can vary, an investment held for less than a year is treated as short-term for tax purposes. Although the term day trading is often used to refer to any type of short-term trading, it specifically refers to buying and selling an investment in the same day. Day trading holding periods can range from fractions of a second to hours. Short-term trading is typically considered an active approach while passive investing is usually associated with longer time horizons and buy-and-hold strategies.

Trade Time
Research has shown that the odds of making money on a steady basis as a day trader are very low. Even if you do manage to beat the odds and become a consistently successful day trader, it will only happen if you have enough time. It will take both time to learn to day trade and time to make actual trades. As the Financial Regulatory Authority (FINRA) states, “day trading requires in-depth knowledge of the securities markets and trading techniques and strategies”. Learning the mechanics of markets as well as trying out different trading styles can take months or years. There is a wide range of short-term trading styles and techniques. Becoming familiar with a variety of strategies and finding one that may be most suitable may take a significant amount of time.

Shorter-term trading strategies are sometimes described with the metaphor of “picking up nickels (or pennies) in front of a steamroller”. One of the striking elements of this image is the idea of picking up the minute sum of nickels (or pennies). The image does not use one hundred dollar bills, but small-denomination coins. The description implies that each trade may not yield a very high return, and that a large number of trades, or nickels, are needed to sum to a desirable amount of money. The average person investing for retirement may not have the time it would take to make a large number of trades that would be needed to add up to a significant amount of money. While a long-term passive investor may make a handful of transactions in a year, an active short-term trader may make multiple trades within a day or even in minutes. Day traders may need time to monitor and respond to market moves throughout the entire trading day.

Active or Passive
Another striking element of the trading metaphor is the risk involved by being in front of a steamroller. The threat of the ever-present steamroller implies that a traders' transactions are based on timing. The trader has to be quick and nimble enough to grab loads of nickels while keeping distance from the steamroller. If a short-term trader does not time the market right, they could get hit with steep losses if they have to sell to maintain a strategy of high-turnover with frequent buying and selling. However, a long-term investor who is not trying to time the market may not need to sell during a downturn, and may be able to wait-out a temporary dip in prices.

Slim Chances…
For those fortunate enough to have early success at day trading, it will then take time to see if you are lucky or skillful. Luck will likely run out while skill may promote consistency. However, even if you do have the time to learn to day trade, and make frequent transactions, the odds of consistent success may be very slim. In one study, 97% of participants who traded more than 300 days lost money. One team of researchers found most successful day traders are “merely lucky”, and less than 1% of day traders predictably and reliably earn returns above the overall market. Another research team found the vast majority of day traders are unprofitable. Hiring someone to actively trade for you, such as a hedge fund manager, is typically much more expensive than hiring a manager who uses a passive approach. Because of the time, risk, and cost involved in an active strategy, it may be best for the average retirement investor to only day trade for fun. Gambling can be fun, and it may be a good idea to treat day trading like gambling, and to only wager as much as you can afford to lose. For retirement investors, a passive long-term approach of regular investments without trying to time the market may be the best strategy.

August 2, 2023

Markets Demystified is published the first and third Wednesdays of each month, and explores how stock market investing can relate to personal finance.

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