If you’ve ever watched cable financial news, you’ve certainly had to sit through commercials offering tips on day trading stocks or perhaps currencies. These flashy ads are certainly convincing. After all, who doesn’t want to earn excess profits and live a wealthy lifestyle?
Well, we all know the old adage “If it sounds too good to be true, it probably is.” There have been a number of scams concerning day trading over the years. There’s also been some debate as to whether day trading offers the type of profit potential for investors that those hyping it would have you believe.
Here at Investor Junkie, we're skeptical of these hollow promises. In fact, we don’t recommend day trading at all. Here’s why.
What Is Day Trading?
First, here’s a brief rundown of what day trading is. Investopedia defines it as “the buying and selling of a security within a single trading day. This can occur in any marketplace but is most common in the foreign exchange (forex) market and stock market.”
By definition, day traders need to monitor the markets for the securities they trade on a continual basis. They also need to understand the market forces that impact pricing. And of course, they need to execute trades based on an objective system versus letting their emotions govern their actions.
Huge Time Commitment
Day trading is not an endeavor that you can do on a here-and-there basis. Whether you are trading stocks, currencies, commodities or futures contracts, the trading should be done when the market for these items is open. Day traders have to develop a system and spend most of their time examining the market with a fine-tooth comb for signals that it’s time to buy or sell. So in order to be a successful day trader, it’s practically going to have to become your job.
I live in the Chicago area. Over the years, I’ve known a few traders on the various commodities and futures exchanges located here in the city. These are the ultimate day traders. Each of them impressed me as a professional who understood the markets they were trading in, as well as the impact of volatility (or the lack of volatility) on the commodities or futures contracts they were trading.
These were not people who took some course or who read a couple of books and then started trading one day. Becoming a good day trader isn’t a hobby by any stretch of the imagination. It takes a lot of time, skill and expertise.
Greater Capital Requirements
Day trading can result in rapid gains and losses… in a single day. Typically, day traders will want to have sufficient capital reserves.
In the case of day trading stocks, the SEC (Securities and Exchange Commission) has set a $25,000 minimum margin requirement for a “pattern day trader.” The SEC defines this as:
Any customer who executes four or more “day trades” within five business days, provided that the number of day trades represents more than 6% of the customer’s total trades in the margin account for that same five business day period.
There are no minimum capital requirements for currency traders. Those contemplating day trading should be sure to check for any requirements regarding the markets or investment vehicles they will be trading in.
(And if you've got less than these steep minimum requirements but want to invest, here's how you can get started with only $1,000.)
Higher Tax Rates
Gains and losses on day trading activity are subject to taxes just as with gains and losses on other investment income. Given the potentially high volume of trades, it is critical that you keep track of these gains and losses so as to not misreport your income to the IRS.
Gains from day trading are considered short term and are taxed at a higher rate than long-term capital gains. Currently, the gains made on investing assets that are held for more than one year are taxed at 15%. If you’re seeing gains on assets held for a shorter time period, you’re going to have to pay a tax rate starting at a whopping 28%.
You Could Lose Your Shirt
Of course there’s a very major reason we don’t recommend day trading. Here at Investor Junkie, we believe that the best investments are made with your long term in mind. Whether you invest in real estate through a crowdfunding platform such as Fundrise or in ETFs (exchange-traded funds) in your IRA with a robo advisor like Wealthfront, the goal should be not to make huge gobs of money but to protect and steadily grow your savings.
Day trading is akin to gambling. And just as if you were a high-stakes player at a roulette wheel in Vegas, you could lose your shirt in the blink of an eye. Even professional traders hit slumps of their own doing or related to market or economic factors beyond their control.
How much money can you afford to lose day trading? Do you have the discipline to set a limit and walk away if losses reach that limit?
This is an issue of emotions and — of course — is not limited to day trading, but it is important that anyone who embarks on day trading set limits and stick with them.
If you are thinking of becoming a day trader, it’s important that you look beyond the hype and understand what’s involved, including the potential risks and rewards. And if that doesn’t sound like an appealing proposition to you, you might want to look at safer ways to invest.
Here at Investor Junkie, we’re big fans of investing in real estate — be it through individual fix and flips or through crowdfunding platforms. In fact, we’ve found several ways in which real estate investments beat the stock markets.
If that’s not your thing and you’d rather explore the stock markets, there are plenty of great stockbrokers that have tools to help users become successful active traders. For example, TD Ameritrade offers lots of cool features to help you make the right market choices.
We believe that investing should be about improving your future, not potentially losing it. That’s why we don’t recommend day trading to our readers.
What do you think?