We’ve seen substantial growth in individuals working from home, with the number of telecommuters more than doubling over the past 10 years. Partially fuelling this trend are market opportunities that facilitate flexi-working.
One recurring online theme is websites teaching you how to make money day trading, by buying and selling stocks from your home desk. These websites start with outlining the benefits of working from home and explaining how easy it is to make money from day trading.
Day trading sounds like a dream job. You can work from home, all you need is a computer and an Internet connection. You click on the buy/sell button a few times a day and the money rolls in. All the books make it sound so easy, the online brokerage fees are low, and with so many success stories in the media, it seems like just about anyone can do it.
But you know what they say – If it sounds too good to be true, it probably is! Remember that the internet is full of false information – Anyone can post anything online. So what you need to do is strip away the fiction from the fact, and ask: How many people are really making money? And how much are they actually making?
Who Makes Money?
You will find a wealth of literature on how to earn a living day trading in the financial markets. People are willing to share their ‘secret techniques’ if you buy their e-book or attend one of their seminars. Given that these individuals and corporations are still charging for their advice, do you think they are actually making large amounts of money day trading? Probably not.
The traders that are making a killing in the market don’t have time to write e-books or give seminars. In fact, they probably wouldn’t even want to tell you how they do it. After all, if everyone is using the same technique, it would reduce their opportunities in the market to make money. Thus successful traders will never disclose their secrets. The more likely scenario is that those people writing the books are failed traders who have realised that selling books is a much more efficient way to earn money! So, buyer beware.
I work daily with institutional traders. They are professionals that trade for a bank, and are generally highly educated in mathematics, probability theory and financial engineering. And even they lose money! So, if you want to enter the game, remember that the people you are up against are experienced traders backed by big banks. That gives them a big advantage in more ways than one.
For instance, they can change the direction of the market by entering or exiting trades worth millions of dollars. That is also one of the core ways in which they make profit – By being market makers. When a client wants to buy or sell a financial product, these traders earn money from the bid/ask spread they charge and the sales margin they add. This is guaranteed income and independent of the direction of the market. You don’t have that certainty!
In fact, brokers who enable you to connect to the financial markets will also charge you fees for each transaction you make or any real-time market data you subscribe to. So, when you buy or sell a stock for instance, you have already lost money through the bid/ask spread and the transaction fees. This means that if you buy and immediately re-sell the stock, you will lose money even if its listed price has not moved.
In fact, even if you make a small profit on the sale, this may not be enough for you to break even. It is not a zero sum game where someone wins and someone loses. There are middle-men who will earn money from the loser and the winner. The odds are stacked against you. Individual traders always start from a losing position, while banks and brokers start from a position of power.
Think about the financial market like a casino. The banks and brokers provide the environment for you to invest. On a single day, people can win and lose big amounts. In the long-term, however, casinos are the real winners. They take little bits of our capital every time we play. You can’t beat the bank!
Day Trading or Gambling?
A lot of people enter the market thinking they found a smart day trading pattern that no one else ever thought about. Really? Banks are hiring the brightest minds and are targeting them at finding market inefficiencies so that they can exploit these to make money. Finding a ‘unique trading pattern’ is about as likely as coming up with a successful lottery system. And even if it was possible, everyone would be day trading in the same way and the inefficiency would correct itself naturally. It doesn’t exist. It’s a ‘holy grail’ that people chase and unscrupulous book authors exploit.
Of course there are always people claiming to be earning a living with day trading. And that is true. Some people do manage to be more or less successful. And, while they are probably more rigorous than most in their strategy, you have to remember that there is also a lot of luck involved. Stocks can only go up or down, so you are always betting on heads or tails.
You can use technical analysis, financial indicators, and macro economic reports to help you make a decision, but it still remains an uncertain event. All you end up doing is gambling on whether the price will go up or down. And if you are lucky, you will win. If you are really lucky, you’ll sometimes have a real winning streak.
Then again, it is also possible to hit 10 heads in a row with a coin toss. It is a matter of probability, you have 1 chance out of 1024 to hit 10 heads in a row. Don’t let one lucky person who hits this streak brag about how they broke the system and convince you that is all too easy. For every one winner, there are thousands of losers who you will never hear from.
Numerous studies have demonstrated that randomly picking stock would lead to the same result as carefully studying the market and investing in it. This is one area in which even monkeys can outperform us! This helps illustrate the randomness of the stock market and the luck needed to do well. You may have a few ‘wins’, but in the long-term you could end up worse off than if you would have left your money in a savings account. Before thinking about making money, you first need to think about how not to lose money. Behavioural finance researchers have highlighted the reality that about 80% of day traders lose money, but are just in denial.
Real Life Experimentation
A few years back, I set up an account to day trade options, which are derivatives products allowing more leverage than plain stocks. I started with an initial investment of $10,000 and traded for 6 months. At the end of that period, I had $11,000, which amounts to a healthy 10% profit. I’d like to share with you my learning from this experience and explain to you why I quit although I was making money.
First of all, day trading is demanding. You need to monitor your positions closely – All day, every day. This is not just time-consuming but actually also emotionally quite intense. It can be highly stressful to see the swing between profits to losses, where your stocks are earning you a couple of thousands and then losing you a couple of thousands in a matter of minutes. When you hold positions overnight or over the weekend, then this issue is compounded because ‘after hours data’ comes out and can work against you.
That can create a roller-coaster of emotions, that usually translates into a few sleepless nights, especially if you invest money you cannot afford to lose. There could also be liquidity issues, depending on the market you are day trading. It means that sometimes your stocks cannot be sold at the quoted price – The real market takes over and completely erodes your profit away or, worse, drives you deep into the red, because you can’t find a counterpart willing to buy your stocks. Thus, day trading in the financial markets is not as smooth and efficient as described in books.
Here is a summary of my day trading history. Over the first month, I grew my account by 30%. I felt on top of the world – I was beating the market. However, despite making no changes to my ‘winning strategy’, I lost 50% in Month 2. The same analysis-based strategy that had allowed me to make money a few weeks earlier just didn’t work anymore! It was pretty devastating. Over the next months, I went up and down, realising that on average, I would usually break even, winning and losing almost equally.
When I quit, I took home an extra 10% of my investment. I was pretty happy with that. Until I checked my account that is! Over the 6-month period I had paid over $1,000 to my broker in transaction fees – And that is despite the fact that I had one of the cheapest brokers in the market. This means that I had actually made a 20% profit but gave half of that to my broker. While I was taking all the risk, he was just sitting back comfortably, earning money from me irrespective of whether I was winning or losing. Now that is a nice gig!
Finally, even if you do manage to make money on the stock market, you will need to make a lot of money in order to replace a regular salary. Assuming a profit of 10% per year, which is already quite high and hard to sustain over the long-term, even for seasoned hedge fund managers, you would need an investment capital in the hundreds of thousand dollars to make a living with day trading.
But, most likely, you would end up decreasing your capital over time. The ‘market gurus’ selling day trading courses will always blame your emotions, teaching you their secrets in exchange for a little bit of cash. BUT the real secret is that the system sees individual day traders lose money, while allowing institutions and banks to make risk-free profits.