Day Traders: Dumber Than Ever

Remember the day traders? It's hard to forget the late-'90s stories of lawyers, doctors, accountants, and pizza delivery guys quitting their day jobs to trade stocks in the comfort of their living rooms. No boss, no deadlines, heck, no pants if you didn't feel like wearing 'em. It was the new American dream.

Like many, I assumed that the day traders disappeared when the Internet bubble burst, like Webvan, pets.com, and Ricky Martin. But apparently day trading is back -- and it's dumber than ever.

Live and not learn
A recent New York Times article profiled Andy Lindloff and Steve Gomez, the owners of Today Trader, a 2-year-old Internet venture that enables subscribers to "look over the virtual shoulder" of day traders as they ply their trade in real time. Although Lindloff and Gomez have difficulty describing their investing strategy, they apparently have a knack for making money in the stock market. Lindloff claims that Gomez has averaged somewhere between $100,000 and $120,000 in annual trading profits over the past decade.

While that performance -- if true -- would certainly be impressive, it's hardly indicative of the typical day trader's experience. In a famous study of individual investors' behavior, professors Brad Barber and Terrance Odean found that the most active traders realized the lowest returns. In Barber's latest, yet-to-be-published study, he found that 80% of active traders lost money and "only 1% of them could be called predictably profitable." [Emphasis mine.]

That's because in addition to consistently picking winners, day traders must overcome two significant barriers: high short-term capital gains taxes and trading commissions. Assuming an average of 29 trades per day at $10 a pop, the typical day trader would have to make $72,500 per year just to break even!

In other words, day trading isn't gambling -- it's riskier than gambling. According to Barber's study, you'd have a better chance of making money (and probably have a lot more fun) by heading to the closest casino and playing roulette!

Stop me before I trade again
If they know the odds are so stacked against them, why do day traders keep trading?

As James Surowiecki opined back in 1999, "day trading is predicated on a fundamental misconception about the nature of stock prices, namely that they are somehow persistent and predictable. ... In order to succeed as a day trader over time," he continued, "you have to be one thing: incredibly lucky."

Take luck out of the equation
If you're not among that 1% of incredibly lucky traders, don't worry. Your odds of stock market success are actually quite good, as long as you're willing to measure success in terms of years, and not hours.

The fact is, over the short term -- a day, a week, a month, or even a year -- stock movements are random. But over the long run, stock prices tend to reflect the earnings power of the underlying business.

It is only over the long run that an investor's ability to assess the durability of a company's competitive advantages, the caliber of its management, and the extent of its growth prospects will truly bear fruit. Importantly, long-term-oriented investors also benefit from a lower tax rate and fewer commissions costs, which allows the power of compounding to work in their favor over time.

In other words, rather than worrying about where a company's share price is headed over the next five minutes, I encourage you to focus instead on where the company itself will be in five years.

Long-term investors don't waste their time speculating on the intraday movements of companies that might not even exist in five years, like Freddie Mac (NYSE: FRE  ) and Fannie Mae (NYSE: FNM  ) . These failed financials are hemorrhaging money at an astonishing rate. Even if they manage to survive, there's a good chance that common shareholders will be massively diluted.

Similarly, long-term investors avoid companies with busted competitive strategies. At one point in time, Blockbuster (NYSE: BBI  ) and Borders Group (NYSE: BGP  ) enjoyed a barrier to entry against would-be rivals, thanks to their widespread store bases. However, nimble, capital-light, Internet-based businesses have turned those bricks-and-mortar stores into a strategic liability.

Long-term investors concentrate on companies with strong and sustainable economic moats that are likely to be bigger and better in five years. That's the strategy famously employed by Warren Buffett, and I'd say it's worked pretty well for him so far.

Three long-term winners
At Motley Fool Stock Advisor, David and Tom Gardner focus on companies with sustainable competitive advantages, strong financials, and shareholder-friendly management teams. Here are three companies the Motley Fool co-founders think will reward shareholders over the next five years:

  1. Activision Blizzard (Nasdaq: ATVI  ) : This video game juggernaut boasts a stable of strong gaming franchises, including Call of Duty, Guitar Hero, and World of Warcraft, as well as a rock-solid balance sheet. Increasing consumer demand for digital content should only strengthen Activision Blizzard's industry-leading margins.

  2. Corrections Corp. (NYSE: CXW  ) : The nation's largest private prison operator figures to benefit as its cash-strapped government customers seek more cost-effective solutions. Corrections Corp. can build prisons faster and operate them cheaper than its public peers.

  3. Hasbro (NYSE: HAS  ) : Once a simple toymaker, Hasbro has transformed into a media powerhouse. The company has already enjoyed box office success with Transformers and G.I. Joe; its children's TV network will take center stage this fall.

If those sound like the types of companies you'd like to have carry your portfolio for the next five years (and beyond), click here to join Stock Advisor free for 30 days. You can read all of David's and Tom's recommendations, and see the rest of their best buys for new money now. There is no obligation to subscribe.

While Rich Greifner does not condone day trading, he does appreciate the allure of a pants-free lifestyle. Rich owns shares of Hasbro, Freddie Mac, and Fannie Mae (the latter two bought when he thought they had long-term competitive advantages). Activision Blizzard, Corrections Corporation of America, and Hasbro are Motley Fool Stock Advisor picks. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard and Hasbro. The Fool has a disclosure policy.


Read/Post Comments (28) | Recommend This Article (33)

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  • Report this Comment On May 11, 2010, at 3:27 PM, livedlong wrote:

    the article is the dumbest ever.

    The fools cannot predict the future, and they act like they can.

    For example: Fnm and Fre will survive, with dilution of the commons; the commons have already lost 95% of the value; the survival and the dilution will raise the price many times.....

  • Report this Comment On May 11, 2010, at 5:55 PM, GregTrocchia wrote:

    I beg to differ, livedlong, if the Fools *could* predict the future then day trading would be very profitable for them. *If* you could make a 1% profit guaranteed after trading costs and traded 5 times a day, then you could make almost 145 times your money in 100 days (1.01^500 = ~145, according to my calculator). The catch, there's always a catch, is that no such "crystal ball" that would allow anything like this kind of win streak exists. The best that Fools can do is to choose companies that they believe have long-term advantages as companies and wait for these to be reflected in stock price gains.

    Your point about FNM and FRE, in so far as I can understand it, seems to be that the common stock price has dropped by 95% which provides a large upside should the stock be able to do anything like regain its former pricing. A couple of problems with this are:

    1) If you already own FNM/FRE, the fact that they are now lower in price doesn't help you, it hurts you- putting you in a "hole" that your shares must climb out of before you can break even. Even though this does not apply to new share holders, they still have to deal with...

    2) Massive dilution makes it less likely that a stock will regain anything like its former stock price, contrary to your rather bizarre assertion that it will help raise the stock price. A company with 10 times the amount of stock outstanding and unchanged company value implies that the stock price is one tenth of the undiluted value.

    Finally, there is the small matter that there is no guarantee that such beleaguered stocks will, in fact, survive (which you seem to be taking as a given). Even if the underlying companies do survive, if they go Chapter 11, that will pretty much wipe the stockholders (new or old) out, as many of us found out to our dismay during the recent unpleasantness of 2008-2009.

    Day trading stock of such battered companies is akin to looting a burning warehouse. While you could end up scoring some impressive gains, you run the risk of getting burned, perhaps to death, to do so.

  • Report this Comment On May 11, 2010, at 7:04 PM, mojoe928 wrote:

    What are you talking about Rich? I day trade about 3-4 trades per month and make money on about 95% of those trades. ...and I don't believe its luck.

  • Report this Comment On May 11, 2010, at 7:28 PM, TMFTenacious wrote:

    Mojoe,

    I assume you're writing from your own private island, then? :)

    Feel like sharing the details behind your system's 95% success rate?

    -Rich

  • Report this Comment On May 11, 2010, at 7:38 PM, ChannelDunlap wrote:

    But I can do it from home in my underwear! It's worth the risk if you ask me.

  • Report this Comment On May 11, 2010, at 8:15 PM, GregTrocchia wrote:

    A couple of quick comments, Mojoe:

    1) 3-4 trades a month isn't what I would consider to really be day trading. Rule of thumb: if you would have to worry about the SEC's "free ride" rule if trading a cash account (i.e. buying and sell a stock before the proceeds you used to do the buy have cleared, usually in 3 days) then you can say you are day trading. Most day traders are in and out of the same stock/index/fund multiple times a day, speculating on the intra-day movements.

    2) Success rate alone is immaterial, expectation value is where it's at, baby. Some kinds of transactions are the kind where you can regularly make money until, one day, you can't and then you lose all of the money you previously made and more (e.g. selling credit default insurance in 2008). I am told that such kinds of transactions are known in the trade as "picking up nickles in front of a steamroller". Hence, without the critical info about how much you lose on those "5%" of losing trades, one can't evaluate your methodology.

  • Report this Comment On May 11, 2010, at 8:30 PM, GregTrocchia wrote:

    A couple of quick comments, Mojoe:

    1) 3-4 trades a month isn't what I would consider to really be day trading. Rule of thumb: if you would have to worry about the SEC's "free ride" rule if trading a cash account (i.e. buying and sell a stock before the proceeds you used to do the buy have cleared, usually in 3 days) then you can say you are day trading. Most day traders are in and out of the same stock/index/fund multiple times a day, speculating on the intra-day movements.

    2) Success rate alone is immaterial, expectation value is where it's at, baby. Some kinds of transactions are the kind where you can regularly make money until, one day, you can't and then you lose all of the money you previously made and more (e.g. selling credit default insurance in 2008). I am told that such kinds of transactions are known in the trade as "picking up nickles in front of a steamroller". Hence, without the critical info about how much you lose on those "5%" of losing trades, one can't evaluate your methodology.

  • Report this Comment On May 11, 2010, at 9:25 PM, zman555 wrote:

    THIS IS CRAP WHAT DAY TRADER TRADES 29 A DAY EVERY DAY! WHAT 100 SHARE BLOCKS AT $10 COMISSION. FOOLS SUCKS!!!!!!!

  • Report this Comment On May 11, 2010, at 10:00 PM, aquajava wrote:

    I was a "day trader" in NYC for two years (until Sept 11th). I traded between 5-10million shares if not more per day. I made good money but unfortunately got in at the wrong time, right before the dotcom burst or it could have been so much more. When the Congressional hearings on "day trading" came about, we skewed their numbers so they renamed us "professional traders", defined as "day traders in the the top 5th percentile". There are still a number of firms out there and they still make a mint using top notch custom/always evolving trading programs. You can't even fathom what they have to work with. Trading fees are per 1000 shares and are pretty much insignificant. Back in the day you could actually get a rebate for creating volume. I still have friends in the business and they earn between $5k-$50k per month. Last weeks inefficiency in the market easily produced six figure gains (in a day) for a lot of professional traders. I think the definition of Day Trader has never been clearly defined. That's a good thing though or Goldman Sachs and the rest of the Market Makers would use their government cronies to shut down these small fish in their massive corrupt pond.

  • Report this Comment On May 11, 2010, at 10:03 PM, aquajava wrote:

    BTW, Rich you have no idea what you are talking about :(

    Maybe you should write articles about great dividend stocks?

  • Report this Comment On May 11, 2010, at 10:15 PM, BullishBetty703 wrote:

    aquajava,

    where do I interview for this job? or do I need an MBA from Wharton and an Armani suit?

  • Report this Comment On May 11, 2010, at 10:23 PM, GrumpyOldGuy wrote:

    I don't day trade but I knew that when the author quoted paying $10.00 per trade I realized he did not know the slightest thing about day trading. Who authors this stuff anyway?

  • Report this Comment On May 12, 2010, at 2:10 PM, trhwallst wrote:

    I cannot believe this article got published...talk about foolish...

  • Report this Comment On May 12, 2010, at 2:29 PM, tradersf wrote:

    Considering an average professional day trader pays $2-3 per trade (assuming 1k shares) your numbers are way off. Welcome to 2010.

    This article is pure regurgitation with a healthy dose of advertising for the authors service.

  • Report this Comment On May 12, 2010, at 2:50 PM, ETsjnbadger wrote:

    Another unfortunate example of "Those who can, do. Those who can't, bash those who can while using inaccurate information to back up their claims." I guess live and let live just doesn't exist anymore.

    $10 a pop? Yes. You would have to be dumber than ever to pay something anywhere near that amount. Even at 1000 shares.

    And short term capital gains? Rich, you ever hear of a K-1?

    Yes, the attrition rate of day traders is extremely high. Other than that, the number of inaccuracies in this "article" is laughable.

  • Report this Comment On May 12, 2010, at 6:27 PM, TMFTenacious wrote:

    Hi folks,

    For what it's worth, I pulled my trading statistics from Interactive Brokers' Day Trading Risk Disclosure statement:

    https://www.interactivebrokers.com/Universal/servlet/Registr...

    I actually decided to go with lower trading costs than what the document suggested, since I felt that IBKR's $16 figure was probably too high.

    It may very well be possible to find lower commission costs than those I cited in my article. However, that doesn't change the main point of my article: The vast majority of active traders wind up losing money, and I believe they would be better served by investing with a long-term outlook.

    Thanks for reading,

    Rich

  • Report this Comment On May 12, 2010, at 10:59 PM, trhwallst wrote:

    SO...What is the point of the article?

    This is what I got as the point and I quote:

    In other words, day trading isn't gambling -- it's riskier than gambling. According to Barber's study, you'd have a better chance of making money (and probably have a lot more fun) by heading to the closest casino and playing roulette!

    And that my friend is foolish...I take this is part of the AMUSING program at fool?

    So what you and they are saying is that there is no such thing as high probability intra-day trading?

    Maybe you should spend some time reading or following a trader that does make money and talk about what they do or have done...it would be much more fact-filled and interesting.

    If these guys could trade, they wouldn't be professors.

    By the way most day traders do not pay more than .005 cents a share. If they trade a lot the commissions are much lower. Also, many do not make 29 trades per day.

  • Report this Comment On May 13, 2010, at 1:45 AM, ETsjnbadger wrote:

    Hey shoes, try posting when you're sober next time.

    That IB statement is horrifying, and I actually commend you for bringing the cost down to 10 from 16 per trade. IB is obviously presenting the worst case scenario for legal reasons. But Rich, do you really think daytraders are paying those numbers? Even a beginner doesn't pay .005 per share anymore.

    If I were to provide liquidity on GS tomorrow, I would pay less than 3 bucks on 1000 shares due ARCA rebates. And I'm only doing around 250,000 shares per month, so I'm on the high end of the commission spectrum.

    To be honest though, for the guys who are new, you may be right. I don't know that I'd do it again. But for those of us who have been around awhile, it's about P/L per share, not this fundamental crap. And the longer you've been around, the better it gets simply because of experience.

  • Report this Comment On May 13, 2010, at 8:03 PM, jackhershey wrote:

    The basics of day trading and/or position trading have not changed for over fifty years.

    The advent of PC's did compress the indicator defaults somewhat.

    The article was unfortunate in many many ways. Taking the market's offer is a very resonable trading mission. By simply examining the offer and making it the standard for appraising day or position trading a very different set of conclusions may be drawn.

    For proficient traders, trading costs are considered trivial.

  • Report this Comment On May 14, 2010, at 3:16 AM, gagaliya wrote:

    1) bash prop/short term trading, something the authors/fool clearly know nothing about

    2) preach long term value investing as the only option

    3) shamelessly promote its own paid worthless stock picking service

    I remember when fool.com first started many years ago with a noble purpose as a free education site for the masses, now it's nothing more than many thousands of those scam paid websites.

    Just disgusting....

  • Report this Comment On May 14, 2010, at 1:22 PM, 4mythreegirls wrote:

    love the fact that your precious Million Dollar Portfolio just sold all shares of Hasbro - yet you promote it as a top pick for Stock Advisor. Sounds like one of those GAMBLING hotlines who pick Notre Dame north of the mason dixon line and USC south of it.

  • Report this Comment On May 14, 2010, at 1:36 PM, YodaBuffett wrote:

    On May 13, 2010, at 1:45 AM, ETsjnbadger wrote:

    Hey shoes, try posting when you're sober next time.

    That IB statement is horrifying, and I actually commend you for bringing the cost down to 10 from 16 per trade. IB is obviously presenting the worst case scenario for legal reasons. But Rich, do you really think daytraders are paying those numbers? Even a beginner doesn't pay .005 per share anymore.

    ---------

    Don't commend him too much, he simply stated the conservative IB quote. IB charges 0.005 per trade as well. That's either outdated or just a default estimate. Most brokerages display the upper-ish limit fee.

    Selective sampling =(

  • Report this Comment On May 15, 2010, at 2:41 PM, YOUMAMA wrote:

    I am a "dumb" daytrader

    My commision schedule is:

    -7/10 of a PENNY per SHARE (100 shares=0.70 cents).

    -$120 ARCA, NASDAQ and NYSE market fees.

    -Leverage 10:1

    -Buying power of $100k

    A 300 share trade in RIMM with a profit of 0.45 (long or short) in one day pays for that....

    The rest of the profits for the month are mine...

    This guy is the most ignorant person I've seen...

    Go buy 100 shares of C and sit on it....

  • Report this Comment On May 17, 2010, at 2:49 PM, hbofbyu wrote:

    I know people who make a living on sportsbetting in Las Vegas. They research the teams, look at injuries, look at home-filed advantage and look for innefficient spreads. It can be done, but they do it full time and they don't get rich (a good year is $100,000 and a 10 year average is $60,000).

    But just like Vegas, in day-trading, you can always find a winner (and ignore the 10 losers who fell by the wayside). Statistically, someone is bound to be successful - and because it's human nature, the successful person will attribute their success to their own calculated decisions. You'll see this in every aspect of life. They think they're in control until they aren't. You'll never see a day trader with a 30 year career.

  • Report this Comment On May 17, 2010, at 8:48 PM, trhwallst wrote:

    hbofbyu...

    You'll never see a day trader with a 30 year career.

    Once again someone who doesn't have a clue what they are talking about...

  • Report this Comment On August 02, 2010, at 7:08 PM, TMcNasty wrote:

    Someone just linked me this today. Rich you may have written the single most worthless article on daytrading I've ever read. $10 trades? I'm sorry have you never heard of Sogotrade or Interactive Brokers?

    5 years huh? You can pick five year winners more accurately than I can pick 5-day winners? Highly unlikely. Buy and Cry is dead. You buy (or short) on extreme moves and sell (or cover) when that's overwith. Waiting a full year to save 10% on taxes? No thanks. I like booking 100% gains and just paying them...thanks. Reason # 546 why I never login to this site anymore.

  • Report this Comment On October 23, 2013, at 3:20 PM, hustla4life wrote:

    Some of the greatest day traders I know said that they succeed because of articles like this. Articles that portray day trading as a big risk. This discourages more traders to increase their skill in day trading. Hence, why there is a 95% failure rate. They said that they succeed not because they are intelligent, not because they get lucky, but because they were persistent. It took alll of them almost, about 3 years before they figured out their system. After the euphoric moment, they never lost a single penny and make quite a lot of profit.

    Thank you sir, for discouraging people to trade. Thank you for being average, and telling average people not to be great. Thank you.

  • Report this Comment On December 11, 2013, at 8:03 AM, Trincafe wrote:

    $10 a pop... really, are you serious? lol

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