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Why is Day Trading Stock so Dangerous?

Most investors would be considered long term investors. They choose their investments, rightly or wrongly, and implement by submitting their trades either by phone or online. Then they monitor the investment periodically. These investments may stay in place for months, if not years. The average investor does not look at his portfolio every day or even every month, and he does not trade based on the actions of the market on a particular day. Hopefully they adjust their portfolio periodically based on changing economic and political considerations.

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The Average Day Trader Cannot trade Fast Enough

Day Traders attempt to analyze where the Market and individual stocks are going that day, and take advantage of expected market movements over a very, very short period of time, even minutes. Essentially, these people believe they are smarter than the overall market. It is possible that much money could be made doing this and many professional managers are expert at Day Trading. These Managers have many tools and very high-powered computers to analyze the markets every second. These computers are programmed to react to certain Market News without human intervention. The average investor who attempts to be a Day Trader does not have these tools or lightening fast computers, and is just gambling with his assets. There are companies whose product is providing traders with tools needed for day trading. You used to see these companies advertised on the TV, boasting that investors could become quite wealthy in a short time. However, when was the last time you saw such a commercial? Hardly ever, since most of their clients lost so much money in the 2008 market downturn.

Average investors who attempt Day Trading really have only one source of information and that is watching CNBC, the primary financial network on the TV. CNBC is extremely informative and interesting since the viewer receives a constant flow of useful information about the Markets. The problem, however, is that the viewer cannot act fast enough in Day Trading based on what he sees on CNBC. By the time at the average stay trader attempts to implement a trade based on what he is seeing on CNBC, the computers of the professional managers have already moved the Market based on the same information. The average Day Trader just cannot compete with the professional traders. The other problem with utilizing CNBC as the source of information is that it is very easy for the average viewer to get caught up in the emotions of the CNBC commentators. The CNBC commentators are reporters. Their job is to make the news interesting. One can see and hear their emotions rise and fall with each piece of news that comes out. It is very easy for an inexperienced Day Trader to get caught up in the emotions and the level of intensity that he hears on CNBC every hour. If such an investor is trading based on this information, he most likely is making the same mistakes that the average investor makes all the time, which is to “Buy high and sell low”. Essentially, the average Day Trader is trading based on emotions and old(by minutes) information. He just cannot act fast enough to beat the professional managers. The result, of course, is that the Day Trader ends the day suffering losses. This trader will come in the following day and attempt to make up the previous day’s losses by taking even more risk with larger trades. This is especially true if the investor realizes that, if he has a 50% loss, it takes a 100% gain to get back to even .The end result is predictable and that most day traders lose most if not all of their money.

Ludicrous Day Trading Thought

An interesting concept for the Day Trader would be to do the exact opposite of what he thinks he should do, based on the information CNBC information discussed above. If the Day Trader hears a piece of breaking news which immediately causes the stock market to drop 50 points, the emotional Day Trader may take the very hasty action of submitting a Sell trade. Of course, the computers of the professional managers have already submitted their trades within a nano-second of receiving the same news. By the time the Day Trader attempts to implement the trade the market has already moved. So the Day Trader might actually try taking an action which is exactly opposite of that which his gut tells him to make. In other words, he might try buying when he feels the immediate urge to sell. I agree that this may sound crazy and I am definitely not recommending such an approach. However if an analysis were done, I believe the average Day Trader would find that his performance would have been better if he had taken this action.

How can the Average Day Trader Win?

The only way for the average Day Trader not to lose most of his money in the market is to stop Day Trading. Just do not play this game. Listen to the advice of the CNBC commentators, such as Jim Cramer during is Mad Money show. They always recommend thorough research and long term holding horizon rather than a quick set of transactions to make a profit. Long term investing has been proven to be the way to go. However many Day Traders cannot stop what they are doing because they are caught up in the gambling and Casino atmosphere. The thrill of Day Trading gives the investor a rush and it is very exhilarating. It can actually be an addiction which, while socially acceptable, can wipe out a person’s finances. The average small investor woulod be much better off putting his money in several solid Mutual Funds or ETFs for the long term.

If you are considering being a Day Trader with your portfolio, just do not do it!

References & Further Readings

  1. Optimal stock trading with personal taxes: Implications for prices and the abnormal January returns(George M. Constantinides-1984)
  2. Estimating the Interest Rate Sensitivity of Liquid Retail Deposit Values (James M. O’Brien,David H. Small-1994)
  3. On avoiding bank runs  (Irasema Alonso-1996)
  4. The Valuation of FDIC Deposit Insurance Using Option-Pricing Estimates (Alan J. Marcus and Israel Shaked-1984)
  5. Reaching out: Access to and use of banking services across countries (Thorsten Beck, Asli Demirguc-Kunt, Maria Soledad Martinez Peria-2007)
  6. Operations, Quality, and Profitability in the Provision of Banking Services  (Andreas Soteriou, Stavros A. Zenios-1999)
  7. Trading Costs and Returns for U.S. Equities: Estimating Effective Costs from Daily Data (JOEL HASBROUCK-2009)
  8. Trading group theory for randomness ( L Babai Dept. Algebra-1985)
  9. Pairs Trading: Performance of a Relative ( Evan Gatev,William N. Goetzmann, K. Geert Rouwenhorst-2006)
  10. A Model of Competitive Stock Trading Volume (Jiang Wang- 1994)
  11. A stochastic calculus model of continuous trading: Complete markets  ( J.Michael Harrison Stanley R. Pliska-1983)
  12. SilkRoute: trading between relations and XML  (Mary Fernándeza, Wang-Chiew Tan 2, Dan Suciu-2000)
  13. Strategic trading, asymmetric information and heterogeneous prior beliefs  (F. Albert Wang-1998)
  14. A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets (Harrison Hong, Jeremy C. Stein-1999)
Most investors would be considered long term investors. They choose their investments, rightly or wrongly, and implement by submitting their trades either by phone or online. Then they monitor the investment periodically. These investments may stay in place for months, if not years. The average investor does not look at his portfolio every day or even every month, and he does not trade based on the actions of the market on a particular day. Hopefully they adjust their portfolio periodically based on changing economic and political considerations. The Average Day Trader Cannot trade Fast Enough Day Traders attempt to analyze…

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