Day-Trading Dangers

Day trading may look like investing, but it's far from it. The market's swoon over the past few years probably thinned out the ranks of day traders, but just in case you've given the matter some thought, here's a little info on it.

Investors (at least good Foolish ones) generally study businesses, carefully buy stock, and aim to hold on for the long term -- usually years or decades. They consider themselves part owners of real businesses. Day traders, meanwhile, tend to most of their many investing hours glued to monitors -- tracking the minute-by-minute movement of stocks and placing orders. They'll typically place scores of orders each day and hold each stock for no more than a few hours. Many ignore company fundamentals, focusing only on what might make the stock move in the very short term. While investors may aim to pay long-term capital gains rates by holding stocks longer than a year, day traders are stuck paying at the higher short-term rate.

So, how well do day traders perform? A study by the North American Securities Administrators Association suggested that only about 11.5% might trade profitably. (Of course, trading "profitably" does not even mean that they will beat the S&P 500, a performance available at very low cost via the purchase of an index fund.)

According to managers of day-trading firms cited in a Washington Post Magazine article, about 90% of day traders "are washed up within three months." David Shellenberger of the Massachusetts Securities Division has noted that "Most traders will lose all of their money." A principal of a day-trading firm even admitted that "95% will fail in the first two years." Former Securities and Exchange Commission Chairman Arthur Levitt recommends that people day trade with only "money they can afford to lose."

The people who appear to be making the biggest killing in day trading are those running day-trading firms. These outfits provide day traders with trading equipment and charge them commissions per trade. With each customer trading all day long, the coffers fill quickly. Regulators are investigating this industry.

Understand that people who trade stocks online are by no means necessarily day traders. Accessing brokerages online makes sense for most people, especially when commissions for online trades can be much lower.

Resist articles you may see here or there profiling a successful day trader. Know that for every success, there are countless failures. Don't let yourself or those you care about get sucked into day trading.

If you don't like our take on day trading, see what the Securities and Exchange Commission has to say about it.