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So You Want To Be A Day Trader?

Why wouldn’t you want to be a day trader? You watch the market every day. You’ve seen the stories – make $2,500 in five minutes! You’ve got multiple monitors with a bunch of fancy charts. You’ve seen the movie Wall Street. Michael Douglas looked pretty cool, making moves with the shiny shoes and the slicked-back hair (conveniently forget that he was arrested at the end for insider trading and also probably for starring in Jewel of the Nile). Buy low, sell high an hour later.

Easy money.

Good news! Becoming a “pattern day trader” isn’t something you need to apply for. It’s something you can just go do. Simply execute four day trades in a five-day period (a “day trade” is simply opening and closing the same position on the same day)[1] and congratulations! You are now a day trader in the eyes of the government. Once you have the pattern day trader (PDT) trait tagged on your account, you must keep a balance of $25,000 minimum.

You’re serious about this, though. You want to make the most you can as fast as possible. All this jibber jabber is costing money! The market is moving!

But before clicking ‘Buy Now’ on that Scrooge McDuckian vault, isn’t it strange the government would make a regulation dictating that people who trade too often must keep a minimum balance in their account? Why is that?

It’s the same reason life boats are required on cruise ships – risk. Not so much risk in the markets, but risk in the people. Because day trading has often been a fool’s errand.

A 2000 paper from the Journal of Finance which analyzed 66,465 households at a large discount brokerage firm from 1991-1996 tested two competing theories of investing: (1) investors will trade when the marginal benefit is equal to or exceeds the marginal cost of the trade or (2) investors will suffer from overconfidence and trade to their own detriment[2].

What it overwhelmingly concluded is that investors are overconfident in their abilities as well as the information they are using to make trades.  During that time, the households that traded most frequently earned an annual return of 11.4% whereas the market returned 17.9%. Adhering to the efficient market hypothesis, a perfectly efficient market would present no informational advantage, meaning that patterns in past asset prices give no clues to future returns. Therefore, active trading strategies like day trading should underperform passive strategies.

But you’re saying, “The world has changed a lot since 1996. I have more information at my fingertips than ever before.” You’re right. Does all that additional information really give you a trading edge?

This brings our story into the near present. Another study published in 2020 titled “Day Trading For a Living” examined day traders from 2013 and 2015 to 2017 in the Brazilian equity futures market, third largest in the world in terms of volume. It found that 97% of traders who frequently traded for more than 300 days lost money. A mere 1.1% earned more than minimum wage (in Brazil) and 0.5% made the yearly salary equivalent to a bank teller.

One would expect the traders who were frequently losing would stop day trading all together, realizing that they are just throwing their money into a pit. Shockingly, the study found otherwise, stating that day traders did not learn at all. Behavior exhibited amongst day traders was most closely related to that of the gambler. Just like in Vegas, regardless if a trade won or lost, traders would continue to put money in the market machine and, over time, continue to lose. There was a direct correlation between the frequency of trading and greater losses.

Coupling this with another study postulating that most positive returns for day traders are not based in skill but merely luck[3], it is easy to see how day traders can enter into the same feedback loop that has made casino owners billionaires.

“Wait a minute,” you’re saying, “97% lost money? That means 3% made money. So, you’re telling me there’s a chance…”

The very best day trader during that timeframe made an average of $310 US dollars per day[4]. Perhaps it is prudent that a $25,000 stop sign is plowed into head first. It may hurt, but it prevents investors from accidentally barreling over a cliff because they couldn’t save themselves from themselves.

Then why keep day trading?

Often success is put on a pedestal while failure is squashed down. Stories of day traders saying their accounts doubled in a week get circulated at a disproportionate rate compared to the multitude of traders who lost. At the end of 2020, NPR spoke with an amateur investor whose brokerage account plummeted from $150,000 to only $40,000[5]. His story is far more common than the countless YouTube videos, books, and seminars promising you the secrets of successful day trading – all for a price of course.

97% failed but 3% succeeded. Those stories of traders making $2,500 in five minutes are real. They happened. Pretty convenient, though, they don’t show what happened afterwards. Maybe you can beat the odds, be that 3%.

Or maybe you’d be better off pulling up a stool in front of a slot machine with a pair of clown shoes and a bucket of nickels.

Joe

 


 

I believe working as a collective will always yield stronger results than working alone. Everyone possesses their own unique perspectives, creativity, and problem-solving abilities, making it possible for the entire team to drive towards a goal. It is this collaborative, teamwork driven mentality that attracted me to Coyle. The desire to work with great people, initiate, innovate, and ultimately help people with their own personal goals is what drives me every day.

I earned a degree in Finance from the University of Illinois at Chicago in 2017. Afterwards, I worked for Morgan Stanley and Bank of America/Merrill Lynch, obtaining both Series 7 and 66 licenses. At Merrill, I was on the self-directed side of the business, exposing me to every aspect of the financial services industry.

Outside of the office, I enjoy checking out the latest movies and TV shows, and am always looking for an offbeat suggestion. During football season you’ll find me watching the Bears and simultaneously wishing I could stop watching the Bears because of the stress it creates on my heart – but I’m a fan through and through and just can’t quit!

www.coylefinancial.com
847-441-5644 | coyle@coylefinancial.com 

We value your comments and opinions, but due to regulatory restrictions, we cannot accept comments directly onto our blog.  We welcome your comments via e-mail and look forward to hearing from you.

All information is from sources deemed reliable, but no warranty is made to its accuracy or completeness.   This material is being provided for informational or educational purposes only, and does not take into account the investment objectives or financial situation of any client or prospective client.  The information is not intended as investment advice, and is not a recommendation to buy, sell, or invest in any particular investment or market segment.  Those seeking information regarding their particular investment needs should contact a financial professional.  Coyle, our employees, or our clients, may or may not be invested in any individual securities or market segments discussed in this material.  The opinions expressed were current as of the date of posting but are subject to change without notice due to market, political, or economic conditions. All investments involve risk, including loss of principal.  Past performance is not a guarantee of future results.

Copyright © 2021 Coyle Financial Counsel.  All rights reserved.

[1] https://www.investor.gov/introduction-investing/investing-basics/glossary/pattern-day-trader

[2]https://faculty.haas.berkeley.edu/odean/Papers%20current%20versi

ons/Individual_Investor_Performance_Final.pdf

[3] https://www.wsj.com/articles/when-day-traders-do-well-its-probably-just-luck-11596898228

[4] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3423101

[5] https://www.npr.org/2020/12/08/943224222/he-thought-day-trading-would-be-a-thrill-he-ended-up-losing-127-000

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