Moneybox

Day Trading Is for Suckers

In the wake of last week’s shootings at two day trading firms in Atlanta, a spokesman for one of the companies said that these firms did a good job of warning prospective clients of the risks day trading entails and added that if clients followed the rules the company laid out, day trading was both easy and profitable. Now, easy it may be, although spending six and a half hours staring at a computer screen isn’t my idea of fun. (Which makes you wonder why I’m a writer.) But profitable day trading certainly isn’t, and the current mania for it is less a reflection of the moneymaking opportunities it offers than of the allure of easy credit and the seemingly unstoppable conviction of all gamblers that the house can be beaten.

The numbers are by this point well known, but they’re no less staggering for all that. Most estimates suggest that 80 to 90 percent of all day traders lose money. And that’s in absolute terms: These people leave their day trading careers with less money than they had when they started. Those statistics say nothing about how many day traders lose money in relative terms, which is to say underperform the S&P 500. (If you do worse than an index fund, you’re effectively losing money, because you can invest in an index fund with no labor or opportunity cost at all.) It’s probably safe to say that less than 5 percent of day traders are successful, even without considering the opportunity cost of all the time and energy they have to put into their trading.

This is not, needless to say, surprising. Day trading is predicated on a fundamental misconception about the nature of stock prices, namely that they are somehow persistent and predictable. Now, some interesting academic studies in recent years have called into question the idea that stock prices move only in a pure random walk (i.e., they’re as likely to go up as go down at any one moment). But the walk is effectively random, in the sense that patterns are incredibly hard to discern and basically impossible to take advantage of with any regularity. In order to succeed as a day trader over time, you have to be one thing: incredibly lucky.

The media sort of gets this. But the attacks on day trading have gotten too mixed up with concerns about the impact of online brokerages, the rise of individual investing, and the mania for Net stocks. These are distinct phenomena, and have nothing to do with what’s wrong with day trading. In the long run, the impact of day trading on stock prices is negligible, and although the rise of the Net has facilitated day trading, in fact day trading as it’s done at firms such as All-Tech and Momentum looks more like old investing than new investing, in this sense: The people who profit from day trading are not the day traders, but the firms that reap huge commissions from all the trading, just as old-line brokers tended to encourage people to trade to increase churn in their accounts and boost commissions.

The thing that is most remarkable about day trading, though, is the almost complete absence of a coherent investment theory that could justify the practice. If you read Warren Buffett or Peter Lynch or John Burr Williams, you get a clear sense of the principles that guide their investing. But if you talk to day traders and try to figure out why they believe they can beat the market, you don’t get any real ideas. You just get a host of anecdotes about great trades. The press has exacerbated this problem by including in every article about day trading at least one character who says he’s made hundreds of thousands of dollars. How he did it and why he doesn’t get up from the table and walk away always remain unexplained. Let’s face it. If you go into any casino, there’s going to be someone there who’s up many thousands of dollars. That may help us understand why people keep gambling. It doesn’t help explain what gambling really means economically.

Finally, it’s crucial to remember that day traders have the dubious advantage of playing with the house’s money, since most firms will lend them up to 50 percent of their existing capital to buy more stocks with. That has two consequences: It increases risk, and it makes day traders’ performance even less impressive. If you’re wagering 150 percent as much money as you have, the profits when you succeed will be greater than otherwise. But so will be your losses. What day traders need to ask themselves is: If I had put 150 percent of my money in an index fund, what would my returns have been? But if they could ask themselves that question, they wouldn’t be day traders.