Apparently, day trading is back. The New York Times says so. So it must be.And that’s fine for those who understand that day trading is a nearly sure-fire way to do worse in the market than you would if you owned a low-cost tax-efficient index fund.
Because the vast majority of day traders will do worse than index funds. Even though they’re spending all day trading.
Of course, a big chunk of those day traders won’t know they’re doing worse than index funds. Because they’ll look only at their gross trading returns. In so doing, they will ignore:
- Brokerage commissions
- Taxes (~50% on short-term gains)
- Research costs
- The opportunity cost of the hours and hours they spend trading (which could be spent doing something else).
But stocks are going up again, which means lots of day traders are making money (because that’s what happens when stocks go up–traders make money). And so day trading is fun and cool again.
Consider the fun one day trader was having the other morning, as described by the New York Times:
[A]nyone hoping to join the day-trade caravan had better wear a seat belt, as Mr. Lindloff’s experience on this Wednesday morning demonstrates. Before lunch, he will buy and sell about 44,000 shares, in 17 trades. He starts off poorly, losing about $500. But a timely bet on a company called Rackspace Hosting (“I don’t know what they do,” he says), as well as quick investments in Applied Materials, Eagle Bulk Shipping and a few others, have turned things around.
“Up $210,” he says, removing his headset. Factoring in commissions, he’s made $60.
Which means that, after factoring in taxes, he’s up $30. Which, pro-rated, is about $8 an hour. But it was fun.
Academics like Brad Barber and Terrance Odean have studied the investment performance of day traders in detail. Not surprisingly, it’s ghastly. Here’s more from the NYT:
The great mass of studies point to the same conclusion: trading is hazardous to your wealth…. The losers far outnumber the winners…
The authors sifted through tens of millions of trades, from 1992 to 2006, and found that 80 per cent of active traders lost money.
“More importantly, we found that if you were to look at the past performance of these traders, only 1 per cent of them could be called predictably profitable,” says a co-author, Brad M. Barber, a finance professor at the University of California, Davis. Everyone else, it seems, was on a short-term winning streak. Even those who did modestly well found their that profits were wiped out, and then some, by transaction fees like commissions and taxes.
“It’s not impossible to make money actively trading,” Mr. Barber continues. “There are slivers of people out there who are quite good. And everyone thinks they will be in that group of 1 per cent.”
Those are some powerful numbers, so let’s review them again:
- 80% of day traders in the study lost money (something that is very hard to do in a bull market)
- Only 1% of day traders in the study were “predictably profitable.”
Put differently, far from this being an enriching line of work, 4 out of 5 people engaged in it pay to do it. Only 1 in 100, meanwhile, make enough to be worth writing home about.
The folks who predictably make money from day trading, of course, are the folks who sell traders tools for their day trading: Information courses, “how-to” advice, data streams, stock charts, technical analysis, trading clubs, investment advice, stock picks, you name it. Those folks do quite well from day-trading. Unless they’re dumb enough to actually trade.
But day trading is fun. Right? And it’s cool again. So, by all means, have at it.
See Also: Here’s What Day Traders Don’t Get
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