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.
