Day Trading and why you should stay away

 

Day trading and why you should stay away

“Money won is twice as sweet as money earned.” ~ Paul Newman

Now that might be true for gambling but how different is day trading in the stock market from gambling itself?

The short answer to that is its gambling with added tax!

There is nothing like quick money in this world! The feeling of earning money doing nothing without any kind of strategy, hard work and preparation gives us butterflies in our stomach but the reality is that becoming rich overnight is just a fantasy many people dream of achieving sitting on their favorite couch sipping some chilled beer and streaming their favorite shows. Nevertheless, it takes time, strategy and implementation to make money.

But day trading promises the neophytes or even some experienced people the former. It makes us believe that quick money is within reach. All we have to do is buy low sell high! That’s the mantra!

Making easy money by day trading is as inconsistent as winning money in a lottery or gambling. Day trading resembles gambling more than anything else. When a gambler with a gifted skill, gambles with a strategy and expertise, he makes money. Day trading is just like that, to make money here you must be extra skillful and also trained. This is a reason why; common people only lose money in gambling and day trading.

On the face of it, gambling and day trading looks so simple. Buying low and selling high is a concept that is so easy to grasp.

But actually, it takes great skills to execute day trading profitably. Still, there are people who after years of experience and harsh lessons practice day trading profitably, they become experts in judging and forecasting stock market patterns.

But how many of us can forecast the stock market accurately? Forecasting the stock market perfectly is nothing less than Godly. The market is so volatile and interdependent on other factors that for a common man, forecasting the market is like asking a blind person for directions.

Let’s look beyond the hype and voracity of making quick money and see how day trading works.

1.TRADING MECHANISMS

1.1 Leveraging Trade:

Leveraging refers to the use of ‘something’ to maximize advantage. That ‘something’ is capital in this case so day traders borrow money and then trade. The borrowed money is used to increase leverage.

Suppose a day trader bought 100 stocks of Apple at USD 250 each. Invested capital by trader is USD 25000.

This capital the trader borrows and then trades.

He decided to sell his holdings later when the stock price rose to Rs 252.

In this case, his profit would be Rs2x 100= USD 200

On this profit, the day trader will pay commission to broker @5% max. It means his profit will still be about USD 190

Day trading also attracts capital gain tax @ 15%, so net of profit will be close to USD 160.

The profit percentage for the trader in this trade is only 0.65%.

Firstly, the stock is volatile then the trader makes it even worse by borrowing money and increasing the risk further and all this, just for a profit margin of 0.65%.

And when the trading volume is more risk also plummets. In the above example, we saw a day trader making USD 160 of net profit with a margin of just 0.65%.

That is, he invested USD 25000 and in return was making just 0.65% profit.

This profit is small, so day traders are forced to do multiple trading in a day which results in the risk increasing manifold.

What will happen if the day trader makes a loss? Not only would he pay back the borrowed money from his pocket but also the commission charges.

 

1.2 Short Selling

We have already seen how day traders use leverage for making money. In short selling, traders buy those stocks whose price is expected to fall (or rise) in a day.

These are the steps of how day trading is practiced by short selling by a trader.

Step 1

Place Sell Order using the trading platform (suppose 100 shares of Apple @ Rs 250)

Step 2

Contacts the broker. Informs them that he does not have shares of Apple. But he would like to borrow some.

Step 3

Day Trader waits till the brokerage firm lends 100 shares of Apple in his account.

Step 4

Day Trader immediately sells the 100 shares of Apple at USD 250 (current market price each)

Cash In: USD 25000

Step 5

Day Trader waits until the market price of Apple falls to say USD 248. At this price the day trader buys 100 shares of Apple.

Cash Out: Rs 24800

Step 6

He returns 1,000 shares to the brokerage first that he borrowed.

 

Ste 7

Profit of Day Trader is the Cash-in minus Cash-out

Profit: USD 200

If a day trader performs 5 such profitable trades in a day, his cumulative profit will be USD 1000 per day.

On paper, this short-selling (margin trading) may look inviting. But in reality, it’s very scary.

What happens if the price rises instead of falling?

2.Day Trading Vs Investing

Most people have ruined their life in day trading by starting to trade without knowing its basics. If our idea is only to buy low and sell high, we are heading for a disaster.

We must first understand that day trading is not investing. Day trading and investing are two separate ways of making money.

An investor buys stocks with the intention of holding it for a long time while a trader buys stocks with the intention of selling it on the same day or in a few days.

Investors analyze the business fundamentals of a company and then buy its stocks for a long time sometimes even years. They act as a mini stakeholder of the company so the company’s growth is directly related to their own. Long term growth of such stocks easily beat inflation as the business itself is growing very fast.

 Traders just look at the stock price and care least about its fundamentals. They act on intuition and predict the short-term direction of the stock. This superficial approach of day trading makes it so risky.

We all know that stock prices are very volatile. It is the same for an investor and day trader. Investors are ready to wait for the long term to neutralize price volatility. In the long term, a fundamentally strong business will show a definitive growth trend.

 

Fig1 (image from Quora)

For a day trader, the approach is different. Day traders do not want to neutralize the volatility to make money. Instead, they want their stocks to be as volatile as possible. The more the stock volatility the higher is their chance to make money. This high volatility inherently associated with day trading makes it so risky.

Conclusion

Let it be leverage or short selling trading strategy, the risk of loss when one puts his hard-earned money to work like this is insane.

The skill required to use leverage and short selling is very specific.

Most common people don't have the required skill of executing trades profitably using leverage or short selling. Therefore, it's best to study and understand the market before throwing out cash.

“The stock market is a device for transferring money from the impatient to the patient” -Warren Buffet

 

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