What Day Trading Is Not - dummies

What Day Trading Is Not

So much mythology surrounds day trading: Day traders lose money. Day traders make money. Day traders are insane. Day traders are cold and rational. Day trading is easy. Day trading is a direct path to alcoholism and ruin.

Day trading is not investing

Day traders never hold a position for more than a day. Day trading is most definitely not investing. Day traders perform an important function to the capital markets because they force the price changes that bring the supply and demand of the market into balance. Day trading, however, doesn’t create new sources of funding for companies and governments. It doesn’t generate long-term growth.

It’s not gambling

One of the biggest knocks on day trading is that it’s just another form of gambling. And as everyone knows, or should know, in gambling, the odds always favor the house. That’s not the case with day trading, however. Consider these points:

  • In day trading, the odds are even in many markets. The options and futures markets, for example, are zero-sum markets with as many winners as losers, but those markets also include people looking to hedge risk and who thus have lower profit expectations than do day traders.

  • The stock market has the potential for more winning trades than losing trades, especially over the long run. For this reason, the stock market isn’t a zero-sum market, like options and futures markets. In the stock market, the odds are ever-so-slightly in the trader’s favor.

In all markets, the prepared and disciplined trader can do better than the frantic, naïve trader. That’s not the case when gambling, because no matter how prepared the gambler is, the casino has the upper hand.

People with gambling problems sometimes turn to day trading as a socially acceptable way to feed their addiction. If you know you have a gambling problem or suspect you are at risk, taking up day trading is probably not a good idea for you. Day traders who are closet gamblers tend to make bad trades and have trouble setting limits and closing out at the end of the day. They turn the odds against them.

If you use risk capital, day trading’s not dangerous

A lot of day traders lose money, and some lose everything that they start with. Others don’t lose all of their trading capital; they just decide that there are better uses of their time and better ways to make money.

A responsible trader works with risk capital, which is money that she can afford to lose. She uses stop and limit orders to minimize her losses, and she always closes out at the end of the day. She understands the risks and rewards of trading, and that keeps her sane.

Many day trading strategies rely on leverage, which is the use of borrowed money to increase potential returns. Leverage carries the risk of the trader losing more money than is in his account. However, brokerage firms, which don’t want that to happen, will probably close a leveraged account that’s in danger of going under. That’s good, because it limits your potential loss.

It’s not easy

Along with the relatively low rate of success, day trading is really stressful. Concentrating on the markets and knowing that real money is at stake takes a lot of energy. The profit amounts on any one trade are likely to be small, which means you have to be persistent and keep placing trades until the end of the day.

Some traders can’t handle the stress. Some get bored. Some get frustrated. And some can’t believe that they can make a living doing something that they love.