If you’re wondering this, you are not alone. Day trading can be appealing for a lot of reasons. Investors who want to take a hands-on approach to investing may be drawn to the various strategies and research required to be an efficient day trader.
But is day trading a good idea? Is it worth it? Can you make money doing it?
To answer these questions, we’ll start with a brief overview of the practice of day trading.
What is Day Trading?
A quick Google search will reveal there are many different definitions of day trading. The basic underlying concept is to buy a security, hold it for a short period of time, and then sell it. This is done to try and take advantage of short-term, oftentimes small fluctuations in the stock price.
Day traders use specific strategies that are based on historical trends, patterns or swings in the market. Many day traders also trade on credit (also called margin) through brokerage firms in order to leverage their positions and realize higher gains and losses.
In general, day trading takes an incredible amount of self-discipline and patience, as well as a deep understanding of the market and the ability to withstand high risk.
A benefit day traders provide to the market as a whole is liquidity. The sheer volume of shares traded every day helps contribute to an efficient market.
Can You Make Money Day Trading?
One of the questions we hear a lot is, “can I make money day trading?” The answer is, of course it is possible. That answer may surprise you coming from a group that preaches holistic financial planning. Many advisors are quick to shame the practice of day trading without acknowledging that some day traders, in fact, DO make money. The truth is, some investors (albeit very few) have even been able to make a living doing it.
The “but” is an important one. Do day traders make money consistently and what are the risks associated with it? The answer to these two questions are very important because it lays the groundwork for why many holistic financial planners advise to stay far away from it.
Statistics show that about 13% of day traders make money in a given year, and just 1% of day traders make money consistently, year after year.
That’s 1 out of 100. In other words, day traders who try and make a career out of it are betting their life savings that they will be the 1 out of 100 who can make a living doing it. It is for this reason that people often compare day trading to gambling, and it is hard to ignore the similarities. Both offer the possibility for getting rich quick, and some people actually do get rich quick. Both are fast-paced, high-risk, and can provide a bit of an adrenaline rush or a “gambler’s high”. But can day trading actually offer individuals an alternative to traditional or more conservative investment approaches? Statistics (and history) prove that it is extremely unlikely.
Day Trading vs Buy / Hold
Conservative investors often prefer a buy and hold strategy. Buy / hold describes an investment strategy where an investor purchases a security such as a stock, bond, mutual fund, ETF, etc., and holds it for a long period of time, so as to avoid short-term market fluctuations. Purchasing a technology mutual fund and holding it for 10 years means you are riding out the tech industry over that timeframe. You won’t be swayed if a news story comes out that might be damaging in the short term to the industry. Instead, you are confident that in 10 years, the technology sector will be better off than it was 10 years ago, and your investment will have provided a reasonable return.
Day traders are monitoring the daily news and buying or shorting accordingly.
The Risk of Day Trading
The risk of day trading comes from the fact that there is really no way to predict for certain what will happen in the market or with any particular stock. Investors have been trying to do this for years. If there was a formula, we’d all know it by now. We’d all be getting rich off of this.
An article in the Washington Post a while back written about a successful day trader just about sums up what it takes:
“Dylan is a day trader and, to the surprise of no one who knows him, he’s turned out to be rather good one. He’s clever and quick enough to jump on opportunities within seconds of their turning up on his screen, fearless enough to risk losing most of his net worth in one or two trades, disciplined enough not to — and confident enough to know that even if he does, he can make it all back.” (Source)
In other words, to be a successful day trader, it takes perseverance, a willingness to risk everything, an incredible amount of knowledge, self-discipline and, even after all of that, a bit of luck.
Day Trading vs Financial Planning
Knowing what you now know about day trading, it seems almost silly to compare the two, doesn’t it? It really is apples and oranges. Day trading is a high-stress, fast pace, get rich quick, potentially lose it all quick type of process.
Financial planning is a slow process. It is establishing your goals, dreams and desires and coming up with the most likely way to get there.
Day trading invites risk, it thrives on risk, it loves risk. Financial planning manages risk. It minimizes it as much as possible because risk indicates there is something potentially standing in the way of achieving our goals.
A good day trading strategy accounts for current trends, news stories and a constant eye on market movements.
A good financial plan includes a long-term investment strategy which ignores the daily news stories, ignores short-term market fluctuations and instead focuses on the historically-proven methods of buying, holding, constructing a well-diversified portfolio and reallocating as necessary based on several factors as outlined in the financial plan.
A financial plan is constructed with your individual risk tolerance level and financial goals at the forefront so it leaves you feeling less stressed about your future. It may sound boring, but when the tortoise raced the hare…well, we all know the end of that story.