Many ‘get rich quick’ schemes on the web currently holding up day trading as an easy way to make a quick buck. But there are drawbacks of day trading that these same ads never make clear. This article will hopefully add some balance to the online discourse.
When I’m on YouTube, I’m bombarded by ads from ‘gurus’ who want to show me how I can make 100% returns in a month by day trading.
These ads appear to be aimed at younger investors – playing up the idea that those who are disillusioned by the idea of getting a stable job don’t need to bother.
The disturbing realisation is that this is the perfect demographic for online marketers to target.
Less experienced investors are likely to know the least about investing, and as a result, vastly overestimate their ability to day trade. This phenomenon is known as the Dunning Kruger effect.
Online marketing tends to overstate the ease and rewards of day trading and will usually minimise or completely ignore the effort, costs and risk of day trading.
The drawbacks of day trading
In the interest of being very transparent about day trading and the lifestyle (which is often portrayed online as a 5-hour workweek from a Caribbean island), I’ll explain what I see as the main drawbacks:
The majority of day traders lose money
Active fund managers generate a small alpha on average, but after fees they don’t beat the market average.
Further reading: Why it’s impossible to spot a successful fund manager
This doesn’t bode well for amateur day traders, who have less access to good investment training and corporate management of listed businesses.
The hours can be long
The hours of a day trader can be much longer than the opening hours of the financial markets themselves. After all, much trading activity occurs in the first 1-2 hours of a day, so an early morning is essential to prepare for the session. Traders also like to review their trades after the markets have closed.
Also, the forex market trades 24/7 around the world. This can lead to an ‘always on’ working mentality.
Day trading can be emotional and stressful
When you’re trading with your own money, it’s easy to relish trading victories, but beat yourself up when you incur losses.
Many trades won’t go your way. 20% annual return (which is considered an excellent return by any standard) might be formed from 73 winning trades and 56 losing trades.
Those losing trades would be strung together in lengthy episodes which can drive a trader mad with self-doubt.
‘Is the strategy ineffective? Have I lost my edge? Am I making a huge financial mistake?’. You can imagine that all of these questions will rear their ugly head each time you suffer a string of defeats.
It’s also possible to make an error while trading. Perhaps you placed a trade as a hedge but accidentally took the opposite position – increasing your exposure rather than reducing it.
Day trading is self employment
Being self-employed with a volatile income also has its downsides. You might be making £50,000 per year, but you won’t be able to afford a £500,000 house without a mortgage.
Even self-employed people with a regular income are made to jump through a lot of hoops to get a mortgage from a bank. Imagine trying to demonstrate a stable income as a day trader!
Day trading doesn’t produce consistent returns
A myth perpetuated by online marketers is a sense that most days, most weeks and most months are winning months. This is certainly not the case.
The earnings from day trading, if they come at all, will be sporadic and highly dependent upon the quality of your trading ideas.
You may find an excellent strategy but then see no opportunity in the market to actually use it.
This cycle of feast and famine may put pressure on your emergency savings, as your outgoings will still need to be paid, regardless of your trading results.
Day trading can be boring.
Some day traders are surprised at the levels of monotony in an effective day trading day.
Market-leading traders often spend hours per day doing tedious work, such as watching the market for an opportunity to appear or crunching lots of data to test an idea.
If they’re not actively looking at the markets, they’re looking at the latest day trading books or forex trading books for new ideas.
There’s an opportunity cost
When considering day trading as a career option, we need to assess its potential against the other options, such as beginning a well paid graduate career path.
Careers such as accountancy, financial advice, engineering, law and insurance pay reasonable salaries of £22,000 out of university, which can rise to a comfortable range of £50,000 – £100,000+ by the age of 30.
The trade-off in the first year between the returns from day trading, and the starting salary of a traditional career, is a false comparison.
Further reading: How to become a financial adviser
That’s not really the choice on the table.
By snubbing a more traditional job, you are also failing to move up the career ladder and unlock access to the more lucrative and flexible jobs which an employee could enjoy after working in an industry for several years.
This failure to gain credentials and experience is the true ‘opportunity cost’ of choosing to day trade instead.
Therefore, for day trading to be a financially advantageous choice, your returns from trading must be enough to cover:
- The average market return which you could have earned by investing in the stock market by picking a passive fund
- Your trading and news service costs, which may be in the thousands
- The cost per hour of your time spent ‘at work’ trading at your desk
- The opportunity cost of missing out on upgrading your CV
This is a tall order.