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Previously, we talked about how investment can differ from trading, with one of the primary differences being time horizon. While investors are looking to build wealth for use in the future, traders are generally trying to generate income that can be spent now. So, by nature, trading tends to be much more short-term than investing. Investing often involves diversification and holding periods of years and even decades. Though many may consider anything owned for less than a year to be short-term, day trading specifically refers to selling a stock on the same day it is bought. This means that day traders may sell what they buy within hours, minutes, seconds, or even fractions of a second.
During the pandemic, a surge in day trading by individuals may have been sparked by two primary conditions. One of those conditions was that people were forced to stay home, causing many to have time to trade because they were not at work. The other factor that likely contributed to a sudden wave of retail day trading was the ferocious recovery the overall stock market made after collapsing 35% in March of 2020. Many who were new to stocks at the time may have thought they were natural-born traders, unable to make a losing bet, as the overall market rapidly recovered, rising 47% from its 2020 lows in just eleven weeks. However, neither of those conditions are in place anymore, with workers back on the job and markets in a bear market downturn.
If day trading was a sure thing, and if all those who dove into trading during the pandemic had a cohesive strategy that was successful in all market conditions, then you might expect them to all still be trading. Though some share and celebrate their winning trades on social media, there may be many more losing trades that go unposted. One trader was willing to share the story of how they lost $75,000 of credit card and home equity loans by trading. Another shared how they lost over $120,000 trading. Additionally, studies of short-term trading activity have found that chances of sustained success may be very unlikely.
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, and many keep trading despite steep losses. In one study, 97% of participants who traded more than 300 days lost money, with only 1.1% earning more than a minimum wage; leading the researchers to conclude it is “virtually impossible for individuals to day trade for a living”. One researcher tracked 26,000 stocks since 1926 and found 58% of stocks failed to outperform Treasury bills over their lifetimes. The researcher concluded the results help explain why trying to pick winning stocks most often underperforms more diversified portfolios.
Speculating can be fun and treating the stock market like gambling can be fun too, though it may be best to approach trading as if it was an actual casino, wagering only as much as you can afford to lose. For the average investor, Aesop Advisor strongly recommends avoiding using margin accounts or other forms of debt to trade stocks or derivatives with. The Financial Industry Regulatory Authority (FINRA) has a questionnaire for those considering day trading that can be viewed at this link. The following from FINRA may be important to consider. “A day trader should be prepared to lose all of the funds used for day trading. Given the risks, day-trading activities shouldn’t be funded with retirement savings, student loans, second mortgages, emergency funds, assets set aside for purposes such as education or home ownership or funds required to meet living expenses.”
January 4, 2023
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Barber, B., Lee, Y., Liu, Y. & Odean, T. (2014). Do Day Traders Rationally Learn About Their Ability?. SSRN Electronic Journal.
Barber, B.M. & Odean, T. (2000). Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. The Journal of Finance. 55, p. 773-806.
Brad M. Barber, Yi-Tsung Lee, Yu-Jane Liu, Terrance Odean. (2014). The cross-section of speculator skill: Evidence from day trading. Journal of Financial Markets. Volume 18, p. 1-24.
Chague, F., De-Losso, R., & Giovannetti, B. (2019). Day Trading for a Living?. 10.2139/ssrn.3423101.
Håkansson, A., Fernández-Aranda, F., & Jiménez-Murcia, S. (2021). Gambling-Like Day Trading During the COVID-19 Pandemic – Need for Research on a Pandemic-Related Risk of Indebtedness and Mental Health Impact. Frontiers in Psychiatry, 12.
Bessembinder, H. (2018). Do stocks outperform Treasury bills?. Journal of Financial Economics. Vol. 129, Issue 3, p. 440-457.
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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