When you invest, you want to buy low and sell high—but what if you could buy low in the morning and sell high in the afternoon? What if you could find some way to find out when stocks will go up, and buy them before they do?
This is the allure of daytrading, and it has caught millions of people worldwide in its trap. And a trap it is; while stories of daytraders making millions of dollars spread quickly, they’re often just plain not true.
But they’re captivating, which is why they spread in the first place. When a high school student claimed to have earned $72 million daytrading, it quickly caught fire on every media outlet you could imagine. Then it turned out to be completely untrue.
Still, others claim to make a lot of money daytrading stocks, and they brag about their performance to just about anyone who will listen. More frequently, they will tell people that they can teach them how to make a lot of money daytrading—for a fee. Instead of asking why someone who can make money whenever they want by daytrading needs to sell their trading system to others, many get intoxicated with the money-for-nothing sales pitch and waste a lot of money pursuing a system that touts itself as failsafe. In the end, most of them lose money, while the lucky ones may find they just barely break even or earn about what a long-term investing strategy would have earned.
Daytrading doesn’t work—but why not?
The Goal of Daytrading
The idea of daytrading is simple: you buy shares, wait a few minutes or hours, and then sell those shares back at a premium. The problem with this strategy is that it doesn’t always work; there’s no way to tell when shares will go up or down. Some claim to have a system that can predict this, but no academic study has proven these systems to be reliable or accurate at all. In reality, buying shares in the hopes of selling them at a higher price later in the day is more like gambling than investing.
This is why the Securities and Exchange Commission warns against daytrading, noting that it isn’t illegal or unethical, but often involves “severe financial losses.” The few successful daytraders out there readily admit that their first few years of trading involved heavy losses, which took them a long time to recover from.
The risk of daytrading is not limited to just losing a lot of money quickly. Daytrading is a labor-intensive and stressful activity. Daytraders use a variety of tools to make their trades, and they will spend hours at their desk in front of several monitors staring at charts and waiting for the move that they’ve bet on. Sometimes it happens and sometimes it doesn’t; when it doesn’t, money is lost. When it does, money is made. The job of the daytrader is to make sure they get it right more often than they get it wrong, which requires a lot of energy, focus, time, and a bit of luck.
The Long-Term Alternative
It’s for this reason that Warren Buffet warns against trading at all. From Buffett’s point of view it makes little sense to spend so much time and effort into short-term trading, which will likely lose money anyway, when you can simply put your money in a good, profitable company, and let it grow in value over time without having to think about it.
Studies have supported Buffett’s viewpoint. Brokerage firm Fidelity Investments once did a study on which of their clients made the most money, and the conclusion was clear: those who traded the least made the most money. When a former Fidelity employee shared this anecdote to asset manager Barry Ritholtz, he was unsurprised. He had seen several investment accounts remain untouched for a decade or more that had outperformed more during that period than in periods when the same account was more actively managed.