Before You Start Day Trading...
During the past couple of months, I've noticed that day trading has grown in popularity. Given how markets have gone up substantially since the end of March, a lot of people are getting the sense that they're good at it too. Some popular stocks like American Airlines (AAL) or Royal Caribbean (RCL) have seen gains of 20%-40% in as little as single day! So you can see how dabbling in day trading can be tempting; however, this has given a lot of people, what I fear to be, a false sense of confidence in their investing acumen, which could end poorly for a lot people. Having said that, I want to offer some things to be cautious of before trying to get into the world of day trading.
First off, let me start by saying that as a firm, we don't participate in day trading or even buying and selling individual stocks (unless specifically requested by a client or under unique circumstances), and the reason for that leads me into my first point, which is: The Risk of Trading Individual Stocks
The Risk of Trading Individual Stocks
When you put your money into single stock, or even a handful of single stocks, you are exposing yourself to significant unnecessary risk. Your financial success depends on the continued success of a single company (or a handful of companies). We've seen stocks like Blockbuster, Kodak, and Pan Am--once very attractive investment opportunities--go bankrupt. And this kind of thing happens all the time. The world changes, events happen that companies are unable to adapt to, and investors lose. If you have all of your eggs in one basket or even a few baskets, when you lose, the consequences can be significant. This is especially important in times of market volatility where stocks are moving up and down drastically every day
Market Volatility
American Airlines (AAL) had a week at the end of March where the stock price was up 35%, then the following week it was down 33%, then up 33% again the following week. These swings are happening on a day-to-day basis as well. Unless you can time when to get in and when to get out, consistently and correctly, you lose. The only way you can consistently and correctly pick when to get in and out is if you know the future (which no one can do) or you have information that no one else does (and that's referred to as insider trading).
In fact, most mutual funds fail at picking and choosing winning stocks. Out of the roughly 3,000 mutual funds that existed 15 years ago, only 52% are still around today and only 20% actually beat their benchmark (1). That means they lost 80% of the time. These are professional, expert analysts with access to the best tools and resources out there. So the idea that an individual investor can consistently pick winning stocks is extremely unlikely. And while this can be a fun ride on the upswing, it can be devastating on the down.
Tax Consequences
Another factor that is often missed when it comes to day trading is the tax consequences. Generally speaking, you have to pay taxes on your investment gains. If you sell a stock that you've held for longer than 12 months, those gains are considered "long-term capital gains" and you pay a reduced tax rate on that amount (could be as low as 15% or even 0%). However, if you sell a stock after holding it for less than 12 months (as is the case with day trading), you end up paying “short-term capital gains” rates on those, which is much higher. So when you're looking at your Robinhood account and you see these big daily gains, keep in mind that if you sell those stocks in under 12 months, a large chunk of that will likely be paid out in taxes. So you're not actually making as much as you think .
Trading Fees
Another cost to consider is trading fees. These are less common now with apps like Robinhood, which actually incentives people to trade frequently, but if you are on a platform that charges trading fees, you have to factor that into your return because it can quickly eat away at your gains if you're trading frequently.
Emotional Turmoil
Aside from financial turmoil, another risk of day trading is emotional turmoil. Your investment portfolio should reduce stress not to add to it. I recently read on article on Market Watch about a 20 year old rookie investor that got deep into trading options on margin (which is a whole other layer of risk) and ended up $700k in debt. Shortly after realizing this, he ended up taking his own life. I've been seeing several tragic stories like this where people get addicted to day trading and end up in financial ruin. Do don't let that be you.
If You Must..
If you are going to play around with trading individual stocks, don't do it with any significant amounts of money. You worked hard for your money. If you are going to play around, make sure it's not in any amount that's meaningful to you. Don't let it jeopardize your retirement, savings, or livelihood. I know it can be entertaining to watch guys like Dave Portnoy at DDTG, but remember that Dave is very wealthy and can quite frankly afford to lose the amount he is day trading with. But not everyone is in that situation
Stay focused on your long-term goals, and don't sacrifice those goals for the small potential of short-term gains. Invest your money, time, and resources wisely.