How to Make Money Day Trading

As a financial adviser that spends much of my time analyzing financial markets, my online presence has not gone unnoticed by social media algorithms. Generously, these social media giants have increasingly been gracing me with video suggestions and advertisements from experts who claim to have access to exclusive day trading strategies which would otherwise be preserved for the Wall Street elite. These experts, with their persuasive pitches, promise to unveil the secrets to amassing wealth through day trading – for a fee, naturally.  

The seductive appeal of day trading, where with the click of a mouse you are able to benefit from the daily gyrations of stock prices, is certainly a compelling proposition, especially when compared to the alternative of having to maintain discipline and hold your investments over the long-term. Of course, it would be better to take profits daily rather than waiting years. How effective is this strategy when measured against the reliability of a simpler buy-and-hold philosophy?

It's crucial to recognize that every transaction involves a counterpart— On the other side of every share purchase there is someone selling, and on the other side of every share redemption there is someone buying. This means that in order to benefit from mispricing, you would need to hold an alternative opinion about the prospect of a stock as compared to the person on the other side of that transaction. Success in short-term trading, predicated on the belief that individuals can benefit from exploiting mispricing, necessitates a viewpoint contrary to that of the opposing party. This should cause individuals to take pause and consider who it is that’s on the other side of the transaction. Who is it that you are buying from or selling to? Do they know something that you don’t? The evidence is clear, that individuals consistently bear an average performance penalty as compared to institutional investors who enjoy a performance boost. Short-term speculative pursuits are not an even playing field. Before taking up day trading, it is important to consider who it is that you are up against.

A study published in the Financial Analysts Journal, titled “The Profitability of Day Traders,” provides valuable insights into the viability of day trading. The optimistic narrative prevalent in the day trading community is that after an initial learning curve most day traders can make money. Contrarily, the authors of this study reveal a sobering truth: the majority of day traders do not achieve sustained profitability. The authors use US data obtained from a national securities firm from February 1998 through to October 1999 to examine the viability of buying and selling securities on the same day. Key findings from this paper outline a stark disparity between success and failure, with twice as many traders losing money as those making a profit. The top earner taking home $197,000, and the biggest loser facing a staggering loss of over -$748,000 during the period of this study, suggesting that it is in fact very hard to make money and comparatively much easier to lose money.

Before trading costs, traders seemed to fare quite well, with an average gross profit exceeding $8,000 per day. However, net figures told a different story, revealing an average loss of -$750 per trader after expenses— Interestingly, this means it is transaction costs that apparently precluded traders from earning a profit in most cases. There was a glimmer of hope though for some traders, as the authors shared that about 20% of traders were successful in making money.

The US data would suggest that although making a profit by day trading is indeed very difficult, the odds against being profitable are not necessarily overwhelming. The key question arises: of the 20% that were more than marginally profitable, how many attained their profits through superior skill when compared to chance? Wall Street wisdom posits that in general, traders are profitable when the overall market is profitable and lose money when the market is down. This would mean that it would be reasonable to expect some traders to have accrued wealth simply by dumb luck. Unfortunately for the day trading pundits, after controlling for market inertia, the statistical evidence supports the notion that day-trader profitability is in fact more related to movements in the index rather than the trader’s skill.

Brad Barber and Terence Odean have done extensive research in this area as well. In contrast to some of the US based studies that draw on smaller data sets, Barber and Odean have focused much of their research on the Taiwanese market, which is a highly developed market - 12th largest in the world. Taiwan was carefully selected as the chosen region for their research given the availability of data on individual investors. Given the richness of the data, Barber and Odean have been able to publish multiple papers weighing the merits of day trading over the years.  In their 2004 paper “Do Individual Day Traders make Money? Evidence From Taiwan” they were able to analyze 139,000 individual investors between 1995 and 1999. Interestingly, consistent with the US data, they found that 8 of 10 traders lost money on a semi-annual basis, and only a very select few were sufficiently savvy to consistently earn profits net of trading costs.

Of the 20% of traders who did make money, even fewer were able to do so consistently. These select few with strong past performance were actually able to continue to earn strong returns, with the stocks they bought typically outperforming stocks they sold by 62 basis points per day, which was sufficient to cover costs. In a later paper they found that it was less than 1% of the day trader population that fell into the category of those who were able to predictably and reliably earn positive abnormal returns net of costs.

This is consistent with research conducted in Brazil, which is the third largest market in the world in terms of trading volume. In the paper “Day Trading for a Living” the authors found that consistent with Barber and Odean’s Taiwanese findings, just 1.1% of the population were able to earn more than minimum wage. Further, only 0.5% earned more than the initial salary of a bank teller. Ironically, if you were a bank teller and chose to focus on being better than 99.5% of bankers then you would be better off than 99.5% of day traders by many orders of magnitude, all without the accompanying risks.

Despite the allure of turning rapid market movements into substantial gains, the empirical evidence and research consistently underscores the difficulties and risks inherent in this endeavor. The majority of day traders face losses, with only a small fraction achieving sustained profitability, a fact that is often overshadowed by the allure of potential gains. The vast array of data and research from multiple markets in multiple countries unequivocally underscores the challenging reality of achieving sustained profitability in this high-stakes endeavor. With only a minuscule fraction of traders consistently outperforming the market, it's evident that the odds are not in favor of the average individual. This insight invites us to reflect on the allure of speculation, and logic compels us to consider more reasonable investment philosophies guided by discipline and evidence rather than overconfidence and hope.