Day trading is gambling
Q: My brother (and business partner) has gotten into day trading in the last year or so. He claims to be "investing," not gambling, but I've heard many horror stories. Should I be worried?
A: You can always tell when the stock market is getting better, because the day traders come out of the woodwork. Unfortunately, a vast majority will wind up grinding their retirement money into sawdust.
In my opinion, day trading is gambling. Whether or not you should be worried, though, depends on how much money your brother is gambling with and what would happen to your business if he squanders his assets.
To explain why I'm so skeptical of day traders, we must first decide what the term means. In my mind, a day trader is an individual who tries to make fast money by buying and selling stocks, options or other securities after holding them a few hours, days or weeks.
Unlike investors who buy diversified baskets of stocks and hold them for a year or more despite short-term swings in the market, day traders try to profit from those swings by buying low and selling high.
But don't expect a day trader to tell you he's a day trader. The term has gotten a bad rap, primarily because so many of these people got destroyed by the last bear market. So today, they're calling themselves everything from "swing traders" to "market timers." Many claim to have found some magical loophole in the public markets that only they know about.
If you ask these day traders to explain what they're doing, their explanations are usually plausible. And since markets' daily moves are random, there is a chance day traders can make money in the short term. But when they're explaining their "secret" to you, you need to sit back and pay attention and use your reasoning. Keep in mind even some blackjack players may have a lucky night or two, but over time, the odds will catch up with them and reclaim those winnings and then some.
There are two main reasons why the vast majority of day traders will lose their shirts:
• Disadvantage to large institutions. Have you ever seen a $20 bill laying in the street? It's rare, but it does happen. The same thing can happen on Wall Street.
For various reasons, a stock or other security may temporarily (even for a few seconds) become under- or overvalued. Traders are in the business of picking up these $20 bills on Wall Street. Giant Wall Street firms and hedge funds have massive trading desks that do this. They spend millions on equipment and on experts who have the full time job of finding incorrectly priced securities. So, why would your brother, with his discount brokerage account, think he can even have a chance against the resources of these well-funded trading firms?
• Diminishing returns. The next issue is a harsh reality. If someone is lucky enough to find a way to make a short-term profit, the method is quickly copied by other short-term traders. And when enough people try to take advantage of a market inefficiency, that inefficiency disappears.
As you can tell, I'm not a big fan of day trading. I just think the odds are stacked against day traders. The chances of suffering big losses are much greater than the ability to generate gains over the long term.
Study after study has confirmed that most investors are unable to beat the market long term. I have spoken with day traders who have lost large amounts of money, and regretted it.
How you deal with your brother is up to you, though. Maybe he's treating his trading like some gamblers deal with Las Vegas: They play with a set amount of money, say $200, that they are prepared to lose.
If he's just doing it for fun and realizes he'll most likely lose before long, that's one thing. But I would be concerned if he is gambling with money you need to operate the business.
Q: My brother (and business partner) has gotten into day trading in the last year or so. He claims to be "investing," not gambling, but I've heard many horror stories. Should I be worried?
A: You can always tell when the stock market is getting better, because the day traders come out of the woodwork. Unfortunately, a vast majority will wind up grinding their retirement money into sawdust.
In my opinion, day trading is gambling. Whether or not you should be worried, though, depends on how much money your brother is gambling with and what would happen to your business if he squanders his assets.
To explain why I'm so skeptical of day traders, we must first decide what the term means. In my mind, a day trader is an individual who tries to make fast money by buying and selling stocks, options or other securities after holding them a few hours, days or weeks.
Unlike investors who buy diversified baskets of stocks and hold them for a year or more despite short-term swings in the market, day traders try to profit from those swings by buying low and selling high.
But don't expect a day trader to tell you he's a day trader. The term has gotten a bad rap, primarily because so many of these people got destroyed by the last bear market. So today, they're calling themselves everything from "swing traders" to "market timers." Many claim to have found some magical loophole in the public markets that only they know about.
If you ask these day traders to explain what they're doing, their explanations are usually plausible. And since markets' daily moves are random, there is a chance day traders can make money in the short term. But when they're explaining their "secret" to you, you need to sit back and pay attention and use your reasoning. Keep in mind even some blackjack players may have a lucky night or two, but over time, the odds will catch up with them and reclaim those winnings and then some.
There are two main reasons why the vast majority of day traders will lose their shirts:
• Disadvantage to large institutions. Have you ever seen a $20 bill laying in the street? It's rare, but it does happen. The same thing can happen on Wall Street.
For various reasons, a stock or other security may temporarily (even for a few seconds) become under- or overvalued. Traders are in the business of picking up these $20 bills on Wall Street. Giant Wall Street firms and hedge funds have massive trading desks that do this. They spend millions on equipment and on experts who have the full time job of finding incorrectly priced securities. So, why would your brother, with his discount brokerage account, think he can even have a chance against the resources of these well-funded trading firms?
• Diminishing returns. The next issue is a harsh reality. If someone is lucky enough to find a way to make a short-term profit, the method is quickly copied by other short-term traders. And when enough people try to take advantage of a market inefficiency, that inefficiency disappears.
As you can tell, I'm not a big fan of day trading. I just think the odds are stacked against day traders. The chances of suffering big losses are much greater than the ability to generate gains over the long term.
Study after study has confirmed that most investors are unable to beat the market long term. I have spoken with day traders who have lost large amounts of money, and regretted it.
How you deal with your brother is up to you, though. Maybe he's treating his trading like some gamblers deal with Las Vegas: They play with a set amount of money, say $200, that they are prepared to lose.
If he's just doing it for fun and realizes he'll most likely lose before long, that's one thing. But I would be concerned if he is gambling with money you need to operate the business.
