A lot of young people get caught up in the sexiness of day trading. I can see the appeal: it’s faced paced, adrenaline pumping, and “cool”. Some may even make a quick buck due to beginner’s luck. However, in the end, most people end up losing money. That’s why I think it is a good idea to never day trade.

Day Trading vs. Investing

Day trading differs greatly from investing. Day trading is when people buy and sell stocks, bonds, currencies, or other assets within the same day. Day traders rarely hold a position longer than one day.

Day traders want to make profits by taking advantage of small price movements. Profits are generated through frequent and high volume trades. Most traders utilize some sort of advanced technical analysis to tell them when to buy and sell stocks.

In contrast, investors seek to build long-term wealth by buying and holding stocks over the long-term. Investors perform research on index funds (or individual companies) to invest in.

Investments are often held for long periods of time (even decades) to benefit from dividend reinvestment and not paying taxes on paper gains. In other words, investors want to benefit from the magic of compound interest.

Investors don’t care about day-to-day movements in stock prices like traders. Instead, investors want to exploit time arbitrage.

The Dangers Of Day Trading

Day trading is typically very dangerous because there are rarely any reasons for the day to day fluctuations of stock prices. The market goes up and down on a daily basis; that’s what it does. Over the long-term markets tend to go up as the economy grows.

Ben Graham, the father of value investing (and Warren Buffett’s mentor), once said:

The market is a voting machine in the short-term and a weighing machine in the long-term.

Various studies have shown that over 70% of day traders NEVER make any money! Even the Securities and Exchange Commission (SEC) warns about the dangers of day trading:

Day traders typically suffer severe financial losses in their first months of trading, and many never graduate to profit-making status. Given these outcomes, it’s clear: day traders should only risk money they can afford to lose.

Here are four reasons why you should never day trade:

1. Transaction costs add up

I rarely execute more than 3 – 4 buy or sell transactions within a month. In comparison, day traders probably execute more than 10 buy and sell orders within a 10 minute time frame!

Day trading has very slim margins because stocks rarely get big price movements on a day-to-day basis. As a result, traders might be happy profiting two or three cents per share. To make up for the very slim profit, day traders trade in high volumes or sometimes with leverage.

Leverage is a double edged sword: it can juice your returns, but your losses become just as magnified. Those traders that use leverage typically implode at some point or another. Using leverage is a very bad investing rule to break.

For a high volume trader, commissions can easily cost you hundreds or thousands a day (even if you’re just paying a fee of $0.005 per share like at Interactive Brokers).

To quote Ben Graham once again:

Thousands of people have tried, and the evidence is clear: The more you trade, the less you keep

2. Not tax efficient

Day trading is not tax efficient because you are constantly buying and selling stocks. This means that at the end of the year you’ll have to pay out taxes (assuming you have any profits).

Imagine paying taxes on the paper gains on your long-term holdings at the end of every year! That would really put a crutch on your returns. Paying taxes every year disrupts the magnificent power of compound interest.

Under long-term investing, you won’t pay taxes until you actually sell the stock (for a gain). You are effectively allowed to “borrow” the taxes on the paper gain until the stock is sold.

3. Competing Against Professionals

When you’re day trading, you’re competing against professionals with much better software, financial and technical data, and knowledge. These guys trade for a living and have access to much better resources. And many of them are located close to the actual stock exchanges, which mean better trade latency.

And worst of all, most of these professional traders are trading with other people’s (client’s) money, so they don’t feel the same emotions when they lose hard earned dough.

4. Most Programs And Gurus Are Scams

Like timeshares, day trading is an industry ripe with many scams. Many of these day trading programs offer ridiculous claims of making six figures executing trades on the beach and enjoying a great life.

In addition, getting a proper trading setup can be a fairly expensive investment. For starters, you’ll need at least 3 – 4 monitors. That could easily set you back $1,000. In addition, you’ll need access to live stock price data (nope, the free 15 minute delayed data from Google Finance won’t cut it). Finally, those scam artists will probably try to get you to buy into some kind of expensive trading platform or live classes.

Conclusion

Trading is a fool’s game most of the time. Most will never make a cent of profit, let alone market shattering returns. You’ll be better with long-term investing in an index fund and reaping the power of compound interest. Never day trade!

Readers, what do you think? Am I off base here? Let me know with your comments!

Related:

8 Investing Rules You Should Know

How To Survive A Bear Market