How Hard Is It For Active Traders To Make Money In The Stock Market?
A Day Trader is a specific type of individual investor whose investing style is characterized by frequent and rapid buying and selling, and a short average holding period. Most are amateurs (non-professional) who trade part-time as a way to supplement their primary source of income.
Since the mid-1990’s, day trading has grown in popularity. Amateur investors are attracted to this style of investing because of an unsubstantiated perception that day trading is an easy way to earn a great deal of money with minimal initial capital.
Proponents of the practice, along with marketers of day trading systems and services, claim that anyone with a high-speed internet connection and the right trading software can make money in the stock market. But this claim assumes that the playing field is level, and that all investors are competing against “the market.” In reality, day traders are competing against highly skilled professionals who have access to better information. These professionals hire and train the best and brightest minds from the top schools to analyze market data and find the best investment opportunities. The activity of day traders represents a source of profit for professionals.
The dramatic rise in the stock market from 1982 to 2000 created a perception for many that easy money can be made in the market as long as the investor stays abreast of the latest developments.
This misperception is reinforced and perpetuated by the alluring claims of those who sell investment services. The claim is that anyone can get rich, and quickly, without much effort, if they only place their trust in the system or service being sold. This marketing message has proven to be irresistible to gullible and overconfident amateur investors.
For regulators, day trading is perceived as something akin to gambling, and therefore should be regulated in order to protect an unsuspecting public from charlatans and scammers.
Overconfidence
People in general, and individual investors in particular, tend to be overconfident in their abilities to perform many tasks at a level of competency that is above average. They overestimate the precision of their knowledge, the level of their skills, and their ability to avoid mistakes in perception, judgment, and execution. This is especially true for more complex tasks.
For traders, this overconfidence leads to a false belief that they can compete successfully against professional market-makers and institutions, in spite of strong evidence to the contrary.
The degree of overconfidence increases with the importance of the task.
People rate their own abilities and prospects higher than their peers. People even misremember their own past performance in order to avoid the psychological pain of feeling incompetent.
Two independent studies, published 1999
Of 334 day traders studied, only 89 were winners (27%). 245 were losers (73%).
The average profit for all 334 traders was $1,906. But this was before trading costs. When costs are deducted, the average trader showed a loss of $-7,903.
Looking only at the winning traders, the average was a gross profit of $40,262 before costs, and net profit of $26,960 after costs are deducted.
Looking just at the losers, the average was a loss of $-12,027 before costs, and $-20,569 after costs.
According to another 1999 report on day trading, this one from the securities regulator NASAA, only 1 in 26 day traders is profitable after taking costs into consideration. Furthermore, 70% of day traders are likely to lose all the capital they invest in the pursuit of becoming proficient at day trading.
Conclusions
Day traders are twice as likely to lose as win.
Only one trader in five is profitable (earns more than zero).
During rising (bull) markets, the proportion of winners among day traders goes up.
But, during falling (bear) markets, day traders give back everything they gained earlier, and then some.
The influence industry (financial media and marketers) actively promotes the idea that day trading is an easy route to wealth and early retirement. This idea has led to widespread acceptance of the incorrect belief that novice and amateur investors can compete successfully against professionals.
Since most day traders lose money, anyone who is thinking about trying it out should give careful consideration to why they think they will be among the 27% who make money from this activity. Do you really think you have an edge? Or could you be overconfident in the belief that you have exceptional skill, better access to information, and a lower cost structure than professional traders?
Here’s the bottom line. I’m not saying that day trading is a bad idea for all investors. What I am saying is that there is a sharp and expensive learning curve for day traders. Those who venture into the game should be prepared to lose money for the first year or two, before they have a chance of making it into the top 27% of performance. If you are going to try day trading, make sure you have enough capital (at least $25,000) and don’t quit your day job.
Read the 1999 study on day trading here: