Day Trading

“If you really want something in life you have to work for it. Now quiet! They’re about to announce

the lottery numbers.”

– HOMER SIMPSON

DURING THE MEME stock craze of 2021, The Wall Street Journal profiled

a day trader who turned $500 into more than $200,000 in less than three weeks by trading options on GameStop. That’s a life-changing amount of money. This guy hit the stock market lottery. Lucky for him, he has a responsible group of friends when it comes to offering financial advice:

‘You really need to sell,’ a friend said.

He wouldn’t. Some on Wall Street Bets were predicting GameStop would hit $1,000, even $5,000. Hold tight and don’t sell, they urged. We’re in this together.

Finally, his friends staged what Mr. Guha jokingly calls a ‘mini intervention.’ One asked if he would invest in GameStop at the sky-high levels if he had fresh money – if not, he should exit the trade. The argument won him over.

Over the course of the next few weeks, GameStop shares crashed nearly 90%. This is the dream scenario – get in, hit the jackpot and get out.

If only it were that easy. The finance industry wants you to be a day trader. They want you to speculate on short-dated options, over-trade your brokerage account, gamble on leveraged ETFs and churn your portfolio until nothing is left. There are always going to be people who win the lottery, but that doesn’t mean it’s a strategy you should try to pull off with your life savings. Day traders face a much higher hurdle rate than long-term investors for a simple reason – day trading is HARD.

I know, I know, no one likes to hear about the pitfalls of overnight riches when it sounds so fun and lucrative. Wouldn’t it be cool to set up six monitors at your desk, look at lines on charts all day and make bank?! Of course, but I would be remiss if I didn’t share some cautionary tales for those who feel like there’s easy money to be made day trading in the markets.

A study of Brazilian futures traders revealed that 97% of those who traded for over 300 days ended up losing money. Just over 1% managed to earn more than the Brazilian minimum wage ($16 per day), while only half a percent made more than a bank teller’s salary ($54 per day) – all while taking on significantly greater risk. The longer these futures traders remained in the day trading casino, the more likely they were to experience losses – the opposite of long-term buy and hold investing.

A study of individual day traders in Taiwan over a 15-year span found that even the most experienced traders tended to lose money. That’s not surprising – but what is surprising is that even the traders who consistently lost money continued trading through the losses. The vast majority were unprofitable, with only 5% of traders turning a profit. Those who lost money were more likely to over-trade, with unprofitable traders making up 70% to 80% of the total trading volume. If at first you don’t succeed, trade, trade again.

Currency markets might be the toughest challenge for day traders there is. The forex market is highly competitive, operates 24/7, involves loads of leverage, and is influenced by all sorts of economic variables. A study by the U.S. Securities and Exchange Commission (SEC) looked at the performance of individual currency day traders. The results were dismal. Around 70% of retail forex traders lost money each quarter, and on average, a trader’s entire investment was wiped out within a year. Even the “best” quarterly performance among these traders resulted in a 24% loss. It’s like they were trying to lose money.

Finally, a study found that nearly 80% of eToro day traders lost money over a 12-month period. The median loss in that time was 36%.

I could continue with more results and statistics, but it feels like that would be rubbing it in at this point. No need to beat a dead horse here.

Does this mean day trading is impossible? Not necessarily. I’m sure some successful day traders do exist. The problem is these people are essentially unicorns and you are not one of them (neither am I). The longer you stay invested in the stock market, the greater your odds of experiencing gains. With day trading, the opposite is true. Much like a casino, in day trading, the house always wins.

Cocaine brain

Investing in the financial markets is like stepping onto the same basketball court as Steph Curry and LeBron James. You’re not only trading with other individuals, but also institutional investors, hedge funds, professional money managers, algorithmic trading firms run by codebreakers and PhDs, and millions of other traders and investors who have more information, computing power and market knowledge than you. In the markets, you’re also competing against yourself.

In Your Money & Your Brain, Jason Zweig explores how your brain influences and responds to financial decisions and outcomes. His findings are both alarming and enlightening.

Brain scans reveal that the neurological response to making money on investments is nearly identical to that of a person high on cocaine or morphine. The brain perceives financial gains and drug-induced highs in a similar way, so you need a bigger hit each time for the same emotional response. After experiencing a pattern just twice, the brain expects to see a third repetition automatically since we humans are pattern-seeking creatures.

Moreover, research shows that financial losses can haunt you even in your sleep – brain scans of sleeping individuals confirm that you can literally feel financial setbacks in your nightmares. Going on a financial losing streak makes it more likely you’ll develop memories of fear and anxiety. These dopamine hits and serotonin blasts are all defense mechanisms that are ill-suited for investors who just want to make some money trading stocks.

A study conducted at a horse racing track examined bettors’ confidence in their chosen horse before and after placing their bets. Researchers found that people became significantly more confident in their horse’s chances of winning after placing their wager than they were beforehand. This phenomenon explains why day trading can be so psychologically challenging – you develop an emotional attachment to your trades to justify your positions instead of judging them by merit.

Willpower alone doesn’t do the trick

Emotions themselves aren’t inherently good or bad – they’re just part of being human. But they do make trading incredibly challenging. Day trading subjects you to your worst impulses all the time. The more often you engage with the stock market, the more your emotions will impact your reactions in a negative way because self-control is a finite resource.

To test the limits of human self-control, researchers studied the dining behaviors of hundreds of patrons at Chinese buffets across the country to understand what influenced their consumption patterns. They found that diners ate less when using chopsticks or smaller plates. They consumed more when using forks and larger plates. Additionally, healthier individuals tended to survey the buffet before picking out what to eat, whereas unhealthy eaters grabbed everything they could fit onto their plates. Seating location also played a role – those sitting closer to the buffet ate more, while individuals facing away from the buffet line consumed much less.

Personal finance experts are enamored with equating health and wealth. After all, everyone knows how to be healthy – eat right and exercise regularly. And everyone knows how to become wealthy – stay out of credit card debt, live below your means and invest wisely. I contend that maintaining good health is far more mentally challenging than accumulating wealth.

You make over 200 food-related decisions daily, making it incredibly easy to give in to unhealthy choices – fast food, snacks, convenience store treats, food delivery apps, and deep-fried restaurant entrees. The temptations are endless. Being healthy requires constant effort. You can’t put your health on autopilot. Working out requires motivation every single time you go to the gym. You also have to exercise your willpower to eat right, which is why studies estimate that 95% of dieters eventually regain the weight they lost.

Staying healthy requires daily commitment, whereas building wealth is

often about making good decisions up front, sticking with them and staying out of your own way. Since knowledge alone is not enough to change behavior, wise investors put rules in place to guide their actions and automate good behavior ahead of time. Some investors need enforced smaller portion sizes, just like the buffet diners.

Scratching the itch

Each year, Americans spend more money on the lottery than on sporting events, books, video games, movie tickets and music combined. Some people love the thrill of gambling, speculation and the dream of hitting it big.

Many finance experts assume people should act like robots and avoid speculation altogether. I’m not naive. People are people and some of us just love to gamble. If you’re one of these people who need to scratch that itch, just do so in a responsible manner. Carve out 5–10% of your portfolio as a behavioral release valve and go nuts – day-trade, time the market, take a flier on some fads, trade options, buy and sell crypto, go long biotech stocks, trade penny stocks, etc. Have as much fun as you like.

I know this is blasphemous to certain investment thinkers, but this can be a worthwhile endeavor if your 5–10% “fun” portfolio allows you to stick to a longer-term, set-it-and-forget-it investment plan with the other 90–95% of your capital. Even people on a diet need the occasional cheat day. You just have to size it right so you don’t overdo it.

I had one of these side portfolios in a brokerage account where I tried my hand at stock-picking, market-timing and out-guessing the markets. It was fun for a while, but then I looked at my results and realized my fun portfolio wasn’t so much fun anymore. Ten percent of my portfolio was causing 90% of my worries because I was constantly checking the performance of my account. It wasn’t worth the brain drain, so I automated that account too.

Sometimes you need to face your chair away from the buffet so you’re not so focused on the day-to-day in the markets or the returns of other investors with different goals and time horizons than you.

Vanguard’s Jack Bogle once said, “This is one of the most important rules of investing. If you never peek from the age of 20 to the age of 70, you’ll rip that first 401(k) statement open at age 70, and I recommend you have a doctor on hand because you’ll go into a dead faint. Your heart might even stop. You’re going to have an amount of money you can’t even imagine.”

That’s not entirely realistic, but he’s directionally right. As long as you’re saving and investing on a periodic basis, paying more attention to your portfolio is not going to make it grow any faster. In fact, the opposite is true. The more you handle a bar of soap the smaller it gets. The same is true with your investments. The odds are stacked against you as a day trader and you’re probably not going to get rich overnight.

In the next chapter, let’s take a look at why volatility is your friend, not a risk like so many investors are often inclined to believe.