Day Trading: What It Is & Why It's a Bad Idea | The Motley Fool (2024)

People on social media occasionally tout the large profits they collect from big, one-day bets made on speculatively held stocks. For some, this form of trading is tempting. What's better than buying a few hot stocks, waiting an hour or two, and then making more than $100,000? It seems so simple and so easy.

Day Trading: What It Is & Why It's a Bad Idea | The Motley Fool (1)

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The reality is that consistently making money as a day trader is a rare accomplishment. It's not entirely impossible, but it's certainly an imprudent way to invest your hard-earned cash. For people considering day trading for a living, it's important to understand some of the pitfalls.

Day trading vs. investing

Day trading vs. investing

Investing in the traditional sense generally does not refer to day trading. While "investing" is a broad term, it's well established that the most efficient way to consistently earn stable and positive after-tax returns is to simply buy stocks or bonds and hold them for the long term.

Long-term, buy-and-hold investors typically do not experience the emotional swings that afflict most day traders -- even when their holdings gain value. If you were to create and maintain a portfolio of low-cost exchange-traded funds (ETFs) instead of day trading, the odds of turning a profit over a long time horizon would be overwhelmingly in your favor.

Definition Icon

Exchange-Traded Fund (ETF)

An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once.

Investors with long-term holdings are well positioned to diversify their investments and mitigate the risk of large losses. Day traders who buy and sell just a few popular stocks have portfolios that are much less diversified, so the movements of any one stock have a much larger effect on their financial health.

Is it a good idea?

Is day trading a good idea?

Day trading is not worth it for the vast majority of day traders. Anecdotally, it's been widely estimated that 95% of day traders ultimately lose money, and it's been empirically demonstrated that about the same percentage of unprofitable day traders continue despite losing money. If you're thinking about day trading for the first time, it's important to know that day trading profits are hard to come by. You can make money day trading, but you'd be in very limited company.

The paradox of day trading is that it may seemlike a good idea, depending on how the stock market is performing. Day trading is essentially a play on the short-term volatility (or price movement) of a stock on any given day. Day traders often buy and sell stock the same day, buying at a perceived low point during the day and then selling out of the position before the market closes. If the stock's price rises during the time the day trader owns it, the trader can realize a short-term capital gain. If the price declines, then the day trader accrues a short-term capital loss.

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CBOE Volatility Index (VIX)

The Chicago Board Options Exchange Volatility Index, or VIX, is an index that gauges the volatility investors expect in the stock market.

A primary reason day trading is a bad idea has to do with transaction costs. The two most visible transaction costs are taxes and fees, such as trading commissions. If you purchase a stock and sell it before one year has passed, then any increase in the stock's value is taxed at your ordinary income tax rate, which is likely significantly higher than the tax rate that would be applied if you held the stock for a year or more. Depending on the trading platform you use and the type of security you're trading, you may also pay a commission every time you buy or sell a stock. These transaction expenses can be costly for day traders.

The inherent nature of the capital markets also typically makes day trading a losing proposition. Minute-to-minute stock price movements on any particular day are little more than random, and they tend to instantaneously adjust to any new publicly available information. Further, when you place a market order to buy or sell, you're trading against a large swath of sophisticated institutional investors and high-frequency trading machines. The probability that you know something professional investors do not -- without it being illegal insider information -- is extremely unlikely.

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Buy Limit Order

An order that instructs your broker to buy a stock or other security only at or less than a specific maximum price.

Given that successful day trading is a rare feat -- and even rarer on a consistent basis -- there are many reasons to stay away from day trading entirely. You worked hard for your money and should avoid putting it in unnecessary peril. Especially when you consider the significantly inflated tax rate assessed on short-term trades (sales of any stocks held for one year or less), it's fair to say that day trading is not worth the risk.

Can you make money?

Can you make money day trading?

Most of the time, day trading is not profitable, but it canbe profitable. Investors sometimes succeed at predicting a stock's movements and raking in six-figure profits by accurately timing the market. These traders may be dabbling in penny stocks to achieve their outsized returns, or they may simply get lucky on occasion -- as many people do at casinos every day.

You may hear stories of some traders making money in professional settings, leaving their investment firms, and calling themselves "successful" day traders -- but without ever having risked their own money in any trades! A non-professional investor trying to learn day trading using his or her own money is unlikely to succeed. On rare occasions, an individual investor can capture explosive gains. But far more common are the instances of day trading ruining lives or financial situations.

For most investors, the best way to grow their money, be it a $10,000 investment or a $20 one, is over the long term.

Is it gambling?

Is day trading gambling?

It's fair to say that day trading and gambling are very similar. The dictionary definition of gambling is "the practice of risking money or other stakes in a game or bet." When you place a day trade, you're betting that the random price movements of a particular stock will trend in the direction that you want.

In the same way that expert poker players study and practice relentlessly to excel at the game, the few successful day traders (who may be at institutions) tend to be extremely well-versed in how markets move in the short term. If a novice poker player were to challenge a table of experts, he or she may conceivably win one or two hands but would almost certainly lose money overall. While day trading is not precisely the same as gambling, one thing remains true about the practice: Most of the time, it is not profitable.

Penny stocks

Are penny stocks the same as day trading?

No, they aren't. "Penny stocks" and "day trading" are two entirely separate terms, but they are often found together in various contexts. Penny stocks are simply stocks that trade for less than $5. Day trading is the act of buying and selling a stock on the same trading day or within a similarly short time period. Many day traders choose to focus on buying and selling penny stocks, but day trading is possible for all stocks, even blue chip stocks.

Some day traders buy and sell primarily penny stocks because of the possibility of a high percentage gain in a relatively short period of time. A stock priced at $1 would only need to gain $1 of value for an investor to realize a 100% return on their initial investment. By comparison, a stock trading at $100 would have to gain another $100 in value before that same 100% gain would be achieved. Day traders sometimes try to exploit quick (and random) upward movements in penny stocks to capture large percentage gains -- despite stocks' movements during any single day being incredibly unpredictable and the gains far from guaranteed.

Taxes

Day trading taxes

When you buy a stock and then sell it within the same trading day, you might make money. But you'd also owe state and federal income tax on the gain, which is equal to the price at which you sell the stock minus the initial purchase price. The short-term capital gains tax rate is the same as the tax rate assessed on your ordinary income (e.g., the money you earn by working).

Definition Icon

Ordinary Income

Ordinary income is any income taxed at ordinary income rates.

Generally speaking, this tax rate is higher than the tax rate assessed on long-term capital gains, which are levied only after a stock or other security stays in your portfolio for a year or longer. The considerably higher tax rates applied to short-term capital gains are another reason to consider holding your investments for at least a year.

Aside from its inherent riskiness, day trading is especially not worth it when you factor in the significantly higher tax rates imposed on short-term trades.

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How you invest your money is ultimately up to you

You get to decide how to best deploy your money. If you decide to day trade, then the most prudent approach is to keep the dollar amounts at risk relatively low -- say, no more than 10% of the value of your overall portfolio. That amount might be enough to gain day-trading experience, but it won't completely devastate your portfolio if your short-term positions incur large losses. If you're also considering other strategies to build your net worth, you'd be wise to learn the many benefits of investing for the long term.

Day Trading FAQs

Is day trading stocks profitable?

The vast majority of day traders never make a profit, and those who lose money often continue to lose money, hoping for a win.

How much does an average day trader make?

More than 95% of day traders lose money, rather than making it. So the average day trader is sitting at a loss.

What stock is best for day trading?

The most popular stocks for day trading tend to be stocks that have a lot of trading volume throughout the day. Their prices will fluctuate more, allowing for a potential day trading win.

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Day Trading: What It Is & Why It's a Bad Idea | The Motley Fool (2024)

FAQs

Why 95% of day traders lose money? ›

The emotional aspect of trading often leads to irrational decisions like panic selling. When the market moves unfavourably, many traders, especially those who are inexperienced, tend to panic and exit their positions hastily. This panic selling often occurs at the worst possible time, leading to significant losses.

How much money do day traders with $10000 accounts make per day on average? ›

With a $10,000 account, a good day might bring in a five percent gain, which is $500. However, day traders also need to consider fixed costs such as commissions charged by brokers. These commissions can eat into profits, and day traders need to earn enough to overcome these fees [2].

Why is day trading considered bad? ›

Instead of waiting for time and compound interest to do the work for them, day traders attempt to beat the market and generate quick profits. While day trading may seem exciting and lucrative, it is effectively gambling with all of the potential upsides and risks you'd have betting through any other avenue.

Do 97% of day traders lose money? ›

However, the harsh reality is that the vast majority of day traders lose money. In fact, studies have shown that a staggering 97% of day traders end up in the red. This statistic is not only staggering, but it's also incredibly disheartening for those who are considering day trading as a means of making a living.

Why do 90% of day traders fail? ›

Without a trading plan, retail traders are more likely to trade randomly, inconsistently, and irrationally. Another reason why retail traders lose money is that they do not have an asymmetrical risk-reward ratio.

What is the average return of a day trader? ›

Day trading offers the potential for high returns, as traders can take advantage of short-term market movements to earn profits. A study showed that traders who held positions for less than a day had an average yearly profit of 14.4%.

Can you make 200 a day with day trading? ›

A common approach for new day traders is to start with a goal of $200 per day and work up to $800-$1000 over time. Small winners are better than home runs because it forces you to stay on your plan and use discipline. Sure, you'll hit a big winner every now and then, but consistency is the real key to day trading.

Can I make $100 a day day trading? ›

You're really probably going to need closer to 4,000 or $5,000 in order to make that $100 a day consistently. And ultimately it's going to be a couple of trades a week where you total $500 a week, so it's going to take a little bit more work.

Can you be rich day trading? ›

While there is no guarantee that you will make money or be able to predict your average rate of return over any period, there are strategies that you can master to help you lock in gains while minimizing losses. It takes discipline, capital, patience, training, and risk management to be a successful day trader.

Do people get rich day trading? ›

Day trading is a strategy in which investors buy and sell stocks the same day. It is rarely successful, with an estimated 95% loss percentage. Even if you do see a gain, it must be enough to offset fees and taxes, as well.

Do people become rich day trading? ›

In summary, if you want to make a living from day trading, your odds are probably around 4% with adequate capital and investing multiple hours every day honing your method over six months or more (once you have a method to even work on).

Who made millions in day trading? ›

Steve Cohen. Steve Cohen's day trading tale is one of a kind. Being the most successful among day traders who made millions, he started as a poker player. His passion for day trading would lead him to develop abilities in day trading and intuitiveness.

What percentage of day traders go broke? ›

Risks of day trading

Success rates among average traders are even lower, with some estimates suggesting the number of people that lose money is as high as 95%.

How many day traders get rich? ›

Conclusion: Approximately 1–20% of day traders actually profit from their endeavors. Exceptionally few day traders ever generate returns that are even close to worthwhile. This means that between 80 and 99 percent of them fail.

Do 90% of day traders lose 90% of their capital within 90 days? ›

Understanding the Rule of 90

The Rule of 90 is a grim statistic that serves as a sobering reminder of the difficulty of trading. According to this rule, 90% of novice traders will experience significant losses within their first 90 days of trading, ultimately wiping out 90% of their initial capital.

Why do so many people lose money day trading? ›

Sometimes the market is easier to trade and you make money right away. But usually, there is a learning curve which means losing some of your capital at the start. After that learning curve, you still need enough capital so that the risk on any single trade is small.

What percentage of day traders actually make money? ›

Conclusion: Approximately 1–20% of day traders actually profit from their endeavors. Exceptionally few day traders ever generate returns that are even close to worthwhile. This means that between 80 and 99 percent of them fail.

Why do traders lose a lot of money? ›

Fear of missing out (FOMO), fear of losing, a lack of patience, and greed are common causes of rash decisions and costly blunders. Ineffective Risk Management: Failure to manage risk properly, such as putting too much money at risk in a single trade, is a common cause of failure.

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