Is Day Trading a Good Strategy?

Short Answer

As an investment strategy, day trading is theoretically junk.

Random Walk Theory

Stock movements for short periods of time are completely random. The drunk staggering left and right from a light pole. There is no pattern. The “random walk theory” has been repeatedly proven.

It’s Luck

If the market is going up in general, day trading will win. It will not win by as much as the market goes up. When the market goes down, day trading will lose. It will lose more than the market. There will be individual stock exceptions – lucky you. Do not, under any circumstance, think it is skill.

Excessive Trading Fees

Trading costs drag day trading below the market both on the upside and downside. There are three major trading costs, commissions, money market yields on the extra cash, and bid/ask spread. Everybody understands commission costs. They think because cheap broker x charges them little or no commissions that there are no costs of playing the game. False. The big cost is the bid/ask spread. When you sell a stock, you sell at the lower of the spread. When you buy (even at the same instant, the same stock), you buy at the higher of the spread. The broker keeps the difference. This difference can be significant and keeps brokers in business.

Higher Taxes

Tax wise, if you make a profit, it is short term capital gain. This gain is ordinary income and is taxed at maximum rates.  If you have a loss, you can only claim a net of $3,000 per year. The extra carries forward. I have a number of tax clients will be deducting $3,000 for the rest of their lives. Long term capital gain (longer than one year holding period) has a much lower tax rate.

Higher Tax Preparation Fee

Each stock trade sale has to be listed on the tax return. It is easier now that I can download and import transactions but is still a pain to reconcile. I once had a tax client with 3,000 transactions. It took so much time, I had to surcharge him an extra fee.

As I’m writing these to help my readers, I would be very appreciative of any input in regards to what I should write next. If you want me to write about a particular topic, please contact me. If you would like to submit a post to my blog, please contact me.

If anything that I mentioned above interests you, please consider downloading my free e-book. The book contains my thoughts on investment management and some information that I think everyone should know. You can also download it below.

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Questions for the comments

Did my explanation make sense? Do you agree or disagree with what I said?

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