Day trading, defined as the purchase and sale of a companys shares on the same day, is often portrayed in the media as being both an exciting and potentially highly profitable endeavour. Thanks to our ability to get access to a lot of information that only professional investors were once privy to, its also a lot easier for anyone to give it a try these days.
The only problem with all this is that, based on academic research, the likelihood of success is very small.
King for a day?
One of the most recent papers to be published on the subject is by three Brazilian academics (Chague, De-Losso and Giovannetti). They were interested in investigating just how possible it was to earn a living from day trading.
From a sample of almost 20,000 people, they found that the proportion of successful day traders fell as the number of days they traded increased. In other words, people became worse at trading the more often they did it.
The researchers then focused on the 1,551 individuals who continued to trade in the equities futures market for more than 300 days. The percentage of successful traders (and how much they actually made) from this group was pretty shocking.
Based on the data, only a minute proportion (0.4%) earned more than a typical bank teller in Brazil in a day ($54) with the best-performing individual taking home $310. A staggering 97% of this sub-group lost money.
Why such appalling numbers?
For one, markets movements are incredibly hard, if not impossible to predict over the very short term. Counter-intuitively, we can be more accurate about where things will be decades from now but not so much in just a few weeks or days. For this reason, day traders are at an immediate disadvantage to long-term investors.
Another issue with day trading is that it requires a high level of emotional discipline. Most of us struggle to keep a leash on fear and greed at the best of times, but trying to do so over a very limited period is arguably even more difficult. A profitable trade in the morning could lead to taking unnecessary risks in the afternoon. Alternatively, some less-than-optimal news could push us to sell and crystallise a loss or take profits too early.
Day trading can also be highly complex, hence why those who do well tend to have devoted a huge amount of time and practice to developing their strategy. Most people wont get this far, relying instead on their intuition (or placing their faith in get-rich-quick scams that have proliferated on the internet).
And there are the costs to consider. Buying and selling frequently may or may not generate profits for those brave/foolhardy enough to do it, but it will always benefit those who get commissions, regardless of the result. Profits can quickly evaporate once fees are taken into account.
In sum, consistently profitable day trading might be achievable by an incredibly small number of people but, to be frank, the chances of it being you, me or anyone else you know are very slim. Most of us are better off sticking to the tried and trusted way of growing our wealth, namely buying stocks in great companies, holding for years and doing very little in the interim. Go elsewhere if youre looking for excitement. Stay Foolish.