Trading can be exciting and the opportunity to beat the market tempting. Aside from playing the lottery or gambling in Vegas, where else are you able to seek out supra-normal returns. It allows you the opportunity to pick that stock that may outperform the market or to test your proprietary trading strategy as the next “sure thing”. However, simply based on the expected risk-adjusted return, day trading turns out to be a very stupid thing to do.
Before starting a fee only, fiduciary ria firm, I worked on Chicago’s “Wall Street” for over a decade, first as a trader, then as an executive. Here’s what I learned and how I advise individual investors who are considering day trading for themselves:
- You will be competing against professionals who use the latest technology, co-located servers, and immediate news aggregation services. Even with these advantages, most professionals fail (over 90% of traders don’t make it).
- Many who succeed usually found an edge swing trading market volatility. It’s virtually impossible for you to do that successfully net of costs.
- When you do get filled, it’ll be likely that an institution or a professional is on the other side. What makes you so sure that you know more than the counter-party?
- By the time you get actionable information from the financial news channels on cable, it’s already being priced into the markets. Professionals rely on immediate news aggregation services that charge considerable fees for access. For all practical purposes, if you are looking for an edge in the short-term, the news on these financial channels is already outdated. And the conveyor belt of “market-gurus” and talking heads in the financial news media make predictions that on average turn out to be worse than a flip of a coin. Why would you follow their advice?
- Consider also that with high-frequency trading, competition is in the milli and micro-second time frames. Additionally, there are algorithms that filter news headlines for actionable word triggers, then instantaneously begin to price that information into the markets.
- Technical and fundamental analysis is usually useless as a trading edge. Mindless strategies like mean reversion work until they don’t and you suffer a blow-out. Fundamentals are priced in. And no one can predict tomorrow’s news.
- Backtested and paper trading strategies don’t translate well to live markets.
- We are not wired for consistent emotional risk preferences. We tend to take profits much sooner than we get out of losses. So, we’ll stubbornly hold on to losing positions longer, hoping that the market comes back in our favor. This means that our individual losses are usually much larger than our individual gains.
- Security picking and market timing are myths. On the contrary, decades of data, research, and real-world evidence suggest that discipline is among the key investment principles that can help explain differences among investors’ returns capture.
- Disciplined investors tend to perform much better than those who try to beat and time the markets.
What does this all mean for investors who are considering day trading? Actually, it’s awesome news. It means that it’s not necessary to take on so much uncompensated risk. You don’t have to try and beat the markets to be successful. It also means that evidence-based investing does not equal average. You can still capture sources of higher expected wherever they may occur. Stick to a simple, well-diversified, low-cost portfolio of index or asset class mutual funds for the long term and you’ll already end up doing better than most of your peers.