Day trading has gained popularity in recent years, propelled by the promise of quick riches and financial freedom. The internet has been inundated with online platforms and self-proclaimed experts claiming to have the secret formula for lucrative day trading. But in reality, is day trading profitable?
Amid the allure, it is necessary to objectively assess if day trading genuinely lives up to its reputation as a profitable endeavour. This article has one goal only, to answer the following question: is day trading profitable?
Day Trading Fundamentals
Firstly, we must define day trading. Day trading is the purchasing and selling of financial instruments such as stocks, currencies, or commodities during a single trading day. Unlike long-term investments, where investors hold positions for a protracted period, day traders seek to profit from short-term market swings.
Timescale & Trading Style
Day trading is conducted on a short timescale, emphasizing intraday price movements. Day traders open and exit positions within the same trading session (a trading session being 1 day) to capitalize on price volatility. This is the key difference between day trading and swing trading (keeping positions for many days or even weeks) or long-term investing (holding positions for months or years).
Technical Analysis
Technical analysis (TA) is widely used in day trading. Traders analyse price charts using various tools and techniques to identify trends, support and resistance levels, and patterns that signal potential entry and exit points. Moving averages, Bollinger Bands and the relative strength index are common technical indicators used to make informed trading decisions. Many argue that TA is more of an art than science and some question its effectiveness altogether.
Volatility and Liquidity
Liquidity and volatility are essential for day traders. Volatility refers to a financial instrument’s fast price movements, which present the potential for short-term gains. Day traders can enter and exit positions quickly at targeted prices in highly liquid markets with high trading volumes without materially affecting the market.
Risk Management
Day trading requires effective risk management to protect cash and limit potential losses. Traders manage risk in various ways, including using stop-loss orders to limit downside exposure, proper position-sizing techniques to control the amount of capital allocated to each trade, and risk-reward ratios to ensure potential profits outweigh potential losses. To be clear, traders expect to lose money on some trades. The idea is to win more than you lose.
Market Analysis
Day traders pay close attention to market news, economic factors, and corporate announcements that can influence price changes. Any information affecting the financial item being traded can influence the decision-making process of a day trader. Staying current on market trends, earnings reports, and world events is critical to identify future trading opportunities and managing risk.
Emotional Discipline
Day trading can be extremely stressful because decisions must be made quickly and under pressure. Emotional discipline is essential for avoiding rash trading decisions motivated by fear or greed. However, this does not only apply to day trading, but investing in general, being emotional with markets is a surefire way to lose money.
The Allure of Day Trading
Day trading has grown in popularity due to several compelling factors. One of the most appealing aspects is the promise of making large gains quickly. But is this promise realistic? Is day trading profitable?
What Does the Data Say?
Believe it or not, the performance of retail day traders have been the subject of research. The work is based on the actual performance of day traders over long time periods. One of the papers, ironically titled “Day Trading is Hazardous for Your Returns” concludes that day traders are overconfident and trade to their detriment. Another interesting finding in the paper is that the most active day traders have trailed the market by 5.5%.
In another paper titled “Just How Much The Individual Investor Lose by Trading”, the findings are more or less the same. Traders who trade aggressively and are willing to trade with urgency are found to incur higher losses. These conclusions are echoed in other papers, but what about the best traders, do they make money?
How the Best Traders Perform
In the paper “Day Trading For a Living?”, the authors find again that the more traders trade, the more they tend to lose. The earnings of the most active traders in the sample are as follows:
- 97% of traders lost money
- 1.1% of traders made more than minimum wage
- 0.5% earned more than a bank teller salary
The disastrous finding though was the lack of evidence for learning amongst the day traders. The researchers did not find any evidence that day traders improved over time. Instead, they found the evidence to most resemble gambling behaviour. This means that paying for trading courses will probably make you worse off, after costs.
What About Commission Free Trading Platforms?
To be honest, the papers I cited above were all published before the advent of commission free trading and smartphones. So maybe traders can make better profits with these platforms right? Unfortunately not! There are a few reasons for this.
The problem with Robinhood, Trading212 and similar platforms is that they are incorporating a social network aspect to it, which combined with their push notifications and top traded stocks lists lead to herd like behaviour that negatively impacts returns.
The Lessons Learned
Our mission at HYW is to spread financial literacy and promote healthy money habits. Unfortunately, we cannot promote day trading as a healthy money habit. In fact, day trading for most retail investors resembles gambling and even trading focussed blogs are echoing the same facts. Before considering day trading as an investment strategy, please consider the following facts:
- The effectiveness of technical analysis is debatable amongst investors.
- The vast majority of traders lose money, despite what you may see on social media.
- Even profitable day traders are trailing the market, so you end up spending a lot of time to make less money than an index fund.
- Remember that professional traders have access to Bloomberg terminals, proprietary software, background in STEM or finance, and most of them fail to beat the market.
- Luck is the most determining factor on your returns as a day trader, not skill, rendering it similar to gambling.
So, Is Day Trading Profitable?
While day trading promises financial independence and wealth, it is critical to understand that it in reality, this is a losing strategy that most resembles gambling. Research shows overwhelmingly that the vast majority of traders lose money, and it is extremely unlikely that you’ll be able to beat the market by trading. So, is day trading profitable? Let us know what you think.
Also Read: How to Set Financial Goals
