To Day Trade or Not to Day Trade

By Doug Tucker

Day trading earned a much-deserved negative reputation during the Nasdaq bubble in the late 1990's. Then you could find many day trading schools and trading rooms that tried to make day trading look like easy money, mostly with video arcade style trading applied to Nasdaq stocks. Most of those rooms and methods are now gone. But replacing the Nasdaq day traders are a new crop of on-line trading rooms and trading schools that focus on stock index futures and forex.

Is this the same madness of nearly a decade ago? Is day trading a viable approach to making money in the markets?

Among the investing establishment, day trading certainly has a negative reputation. When I am in a debate with a typical investor I hear comments such as: "I've never met a day trader that made any money. The costs of commissions and data eat up any profits. Day traders are chained to their computers all day while I am at the golf course. And of course, the really big money is made in the long term and day traders miss all those big trends."

These are all good points. I'll take them one at a time. Of course most people I meet near where I live have never met a day trader that made any money. I live in the Pacific Northwest, far away from the pits and trading floors in New York and Chicago. Most of the traders on the floors of the pits and exchanges are in fact trading in and out of the markets all day long. The are day trading. They are creating liquidity in the markets. They insure that the spread between contract months is in line and liquid. They are there to take the other side of the retail paper that comes into the market. The markets could not exits without the day traders who are professional and make their full time living from the small, numerous trades and small profits they take out of the markets. With new technology and lower transactions costs, off the floor, screen based day traders also contribute to this liquidity.

Are transaction costs and equipment a detriment? It was difficult to overcome transaction costs just a few years ago if you were an off the floor trader. Today commissions are practically negligible, and some of the best charting and data packages are essentially free with a minimum of trading activity.

And what about being chained to a computer all day, while your friends are out playing golf. It is true that to make money day trading one has to monitor the market during the trading day. I guess one could also say that to be a surgeon one has to spend some time at the hospital, and if you were a baseball player you would have to spend some time at the baseball field. It is hard to comment much further if anyone is going to criticize someone's career for actually having to be there while working at it.

Day traders certainly do miss some of the big moves. However, the big moves are rare. More common is the daily up and down pulsation of the market, and day traders are able to capture many up and down swings during the day, while the longer time frame trader has to sit through seemingly endless back and forth chop. In fact, markets spend most of their time trying to find trend direction, with much of that time spent in sideways patterns that make it difficult to make money on a position trade basis. Also, what information does the longer-term trader have to suggest a profit in that time frame? The day trader can more easily see what is there and what is happening right now. It is much more difficult to look out into the future and to make an assessment of what conditions might prevail a year or two out. A day trader doesn't rely on information disseminated by an analyst. He merely trades what is in front of him. He trades what he sees; not what he is fed by outside, non-market-generated information that may be questionable.

And what about the really big, wealth building kind of money that is the objective of the very long-term investor. Warren Buffett has made some really big money, and he is about the longest-term investor you could use as an example. I am quite sure he wouldn't advise day trading. Of course his ability to place large trades is made much easier because day traders are doing their job. It is true that in the very long term, if you are very good at seeing the big picture mega-trends, and use the power of compounding, truly spectacular gains can be had in the very long-term time frame. But even Mr. Buffett has a difficult time maintaining his own track record. Very few portfolio managers can keep up with the broad-based indexes for more than a year or two, let along better them. But the very long term does take advantage of the overall bullish trend of stocks over long periods of time. The same cannot be said for commodities, although to some degree they can keep up with inflation. While short-term day trading can be stressful, long-term investing can try your patience. Can you sit through twelve or more years of no returns or even negative returns? That can happen to the long time frame investor. The market may have long stretches of sideways movement, but the day trader still has the opportunity of many up and down trends available nearly every day.

There are some additional points to consider before considering day trading. It should be obvious, but some people just cannot make decisions quickly enough to day trade. Some people require more information and confirmation by looking at many indicators. With day trading, there just isn't the luxury of time to consult with many indicators, especially if a very short time frame is being used. It is better to use few or no indicators. A certain amount of intuition about the market you trade will in time, with enough experience, begin to emerge, which may take the place of looking at many indicators.

For many the biggest obstacle to day trading is the stress level. Concentration often must be maintained for long period of time during sometimes inhospitable market conditions. The stress level can be magnified as the time frame shortens. The stress can be intense while in a trade if the equipment and technology break down. You can have a backup computer, a backup high speed internet connections, a backup power supply, and backup brokerage accounts. Even with everything backed up the exchange order entry or data feed can go down at just the wrong time. With electronically traded contracts the only thing that can be done is to try to hedge in a similar market, if one is available. Even when all the technology seems to be working, there can be deceptive delays in data during sudden fast market conditions that can introduce slippage that wasn't apparent during testing.

After having traded in many time frames and trading styles, I think the most important issue is to find a trading style that fits the personality of the trader, and not rule out day trading because of misconceptions. There is not a right or wrong answer to the question of the feasibility of day trading. But it must suit the individual trader. For some traders long term investing is totally wrong, and day trading is a better fit. One will only know after trying, and keeping realistic expectations in mind. Also, I think it is a good idea to stay out of the crowd and chose a time frame very short or very long. It is difficult to take profits from the market if you are looking at the same information as the masses. Often either a day trading approach or a very long-term approach will prove to be a less beaten path.

Doug Tucker has a blog with daily commentary on stock indexes, precious metals, and other markets. There are many articles on technical analysis and indicator design and interpretation. To visit go to: http://tuckerreport.com/

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