Risk-free Rate of Return and the Time Value of Money for Day Traders
Any investment or trading opportunity should include compensation for the time value of your money. In day trading, your returns from the time value of money are small, because you only hold positions for a short period of time and close them out overnight. Still, there’s some time component to the money you make.
That smallest return is known as the risk-free rate of return. That’s what you demand for giving up the use of your money, even if you know with certainty that you’ll get your money back.
In practice, investors think of the risk-free rate of return as the rate on U.S. government treasury bills, which are bonds that mature in less than one year. This rate is widely quoted in The Wall Street Journal and electronic price quote systems.
The value of money changes over time. In most cases, this change is the result of inflation, which is the general increase in price levels in an economy. But the value of money also changes because you give up the use of money for some period of time.
If you cannot generate a return that’s at least equal to the risk-free rate of return, you shouldn’t be trading because your return wouldn’t be appropriate to the risk you’re taking.