Why Day Trading Is a Terrible Idea
Investing success is built upon the idea of buying an asset at a discounted price, and then holding it for a long period of time as the value of the asset steadily rises due to the expected risk premium inherent in holding your capital in a risky asset. Eventually, over many years, the asset will be worth much more than the initial purchasing price, and the investor can liquidate the position at a very profitable price.
Trading is different, because there is no expected risk premium. It is inherently very short-term and, in effect is a zero sum game. What one trader gains, another loses. Trading involves buying or selling an asset with no consideration of value. Typically, traders are making buy and sell decisions based on some form of technical analysis.
Every year, thousands of Americans try their hand at the day trading gig, and each year, thousands of Americans lose a ton of money day trading. The reality is that day trading is a terrible idea, and it gets worse the longer one does it and the more capital that one foolishly employs. There are numerous reasons that day trading just doesn’t make rational sense. For example, transaction costs erase profits on a regular basis, the stress level is incredibly high, and it is virtually impossible to succeed over the long-term. It is just a game of luck and luck is increasingly likely to run out the longer that one plays.
Although each of these reasons is substantial, they still are not the primary reason why day trading is a terrible idea. The ultimate reason is because the very nature of day trading virtually dooms a person to guaranteed failure over the long-term because the old cliché, “Cut your losses short, let your winners run,” is completely ignored.
But I Just Want To Be Rich
There are quite a few financial market professionals on the Forbes list of America’s wealthiest individuals. Most got rich selling products and services. A few folks like Warren Buffet, George Soros, Paul Tudor Jones, John Henry, Ray Dalio, and John Paulson—just to name a few got rich through investments. Now, some traders get all pumped up when they hear that real traders, such as Tudor Jones and John Henry are on some of these lists. Those guys started in the trading pits, and now are rich.
The truth, however, is that these guys are not day traders because they realize that the absolute key to trading success is to capture huge winning trades from time to time that are able to compensate for and outweigh the significant costs of trading (losing trades plus commissions). More importantly these traders really got rich trading “OPM” (other people’s money) levered up with debt, which always extracting fees – whether the assets of other people actually made or lost money.
Day traders are doomed because the very nature of their trading style (all positions are closed each day in order to avoid overnight risk) makes it impossible to ever catch a sustained trending trade. This significantly reduces the profitability potential of a trader, and it makes wild financial success very difficult. It’s akin to trying to run a small business and not contracting the best merchant services online. Paying high fees for no reason just does not make sense.
If one wants to take an active role in managing one’s own money, then it is essential to consider ditching any idea of day trading and stick to never trading unless one actually needs the funds. The correct holding period for an investment is forever. Day traders attempt to capture short-term trends, but have no information. They just get eaten alive by professional traders with more knowledge. Day traders lose their lunch money to the financial bullies of greater Wall Street one day, and then bring more money the next day – never figuring out that the bully will be there every day. Any good day for a day trader is a day when Wall Street professionals were busy lightening the wallets of a slew of other day trading suckers.
Tags: opportunity cost
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