Day Trading is risky for a multitude of reasons. Here are some of the common mistakes of day traders.
Academics and market researchers have long observed that approximately 85-90% of the people who engage in day trading fail to reap profits from their investing strategies. The complexity of the day trading strategy combined with the variable nature of the stock markets makes it impractical to predict major price shifts within one trading session. Before we dive into the critical aspects of this infamous strategy, let’s take a closer look into the basics.
Understanding Day Trading
Day traders aim to buy and/or sell securities within one trading session, thereby profiting off of intraday market fluctuations. Such investors aim to capitalize on short term time-sensitive movements having an immense effect on a particular stock or broader markets.
One of the pre-requisites of day trading strategy is maintaining a comprehensive knowledge of current events. In order to learn to day trade, understanding the potential repercussions of any domestic or international event on the markets is of vital importance.
Global markets are extremely receptive in nature and can trigger a price movement on the basis of any economic, social, and political event occurring within a specific country or at the macro level.
Illustrating with an example, the Shanghai Composite Index (SSE), constituting the top 500 companies listed in Shanghai Stock Exchange, gained nearly 2% intraday on the day when the US election results were declared. Let’s take a look at a few major reasons why day traders lose money on a consistent basis.
Gauging the Market Impact
Day traders have to be updated about each socio-economic and political development occurring in the world in order to capitalize on short term fluctuations. While this can be challenging in itself, predicting the market reaction based on a particular event is even more taxing.
Investors have varied attitudes and thereby responses to developments. For example, on May 1st last year, Tesla CEO Elon Musk tweeted regarding the potential overvaluation of shares. The stock opened at $154.55 that day, but closed the trading session at $140.26, down 10.19%. However, on November 16th, when the S&P 500 announced Tesla’s inclusion to the benchmark index, the stock gained only 4.7% intraday.
These two instances embellish the fact that investor sentiment is a key driver affecting stock prices on any given day. However, given the qualitative nature of the metric, it is nearly impossible for day traders to determine the extent to which the markets will fluctuate, even if they are updated with global current events.
Timing a Market Movement
Day traders need to have impeccable timing in order to capture arbitrage opportunities in the markets. Barring the limitations of correctly predicting market timing, the structural delays traditionally caused by delayed execution of trades can lead to huge losses.
Moreover, sometimes, the market response to an event might come to effect on a later date, leaving day traders in a detrimental situation. Citing the market movement during the early days of the pandemic for demonstration, ex-President Donald Trump announced COVID-19 to be a national emergency on March 13th.
However, most stocks trading in American stock exchanges plummeted to their 52-week lows on March 18th or later during the market crash. Thus, while most events have an immediate effect on the markets, the occasionally delayed response can be catastrophic for day traders. Many institutional investors have admitted that it is impossible to perfect market timing.
Limited Access to Capital and Technology
Major financial institutions and banking companies have their own day trading operations, which form the institutional trading group. With high volume day trades requires substantial capital, these traders enjoy unrestricted access to leverage and lines of credit, allowing them to profit by volume.
Banking institutions also maintain strong ties with brokerage firms, ensuring direct execution of orders placed, which is crucial for day trading. Additionally, institutional day traders use high-end analytical software and technical analysis indicators to identify a potential market disruption, all allowing them to capitalize on an emerging trend.
Retail day traders, on the other hand, have to solely rely on their intuition, as these sophisticated software are often extremely expensive. Such investors are also needed for generating substantial profits from day trading, which generally come with huge margin requirements.
Given the risky nature of the investment strategy, brokerage firms often demand substantial leverage in order to process the trades. Also, as retail traders use their own funds to carry out such investments, a lower tolerance for risk induce investors to exit their positions before market signals as they aim to limit their losses, thereby failing to profit off of market fluctuations.
Day trading is an extremely risky trading strategy, requiring an intricate understanding of the markets, as well as access to expensive software. However, even with the availability of the best trading software, timing the markets properly is an immense challenge, causing most day traders to incur hefty losses.
Some of the biggest names in the stock markets such as Warren Buffett and Peter Lynch have advocated having a long-term investment strategy, given the higher return on investment at a relatively lower risk level.
This is a contributed article