The coronavirus pandemic continues to spread, and people around the world are staying home more than ever. Some employers have told their employees not to report to work, while others have had to lay off their employees entirely. Schools in many states are closed, and government officials are emphasizing the need for social distancing in an effort to stem the COVID-19 disease.
Many people are getting desperate with their finances, and they want to take action. For those stuck at home, day trading stocks might seem like an opportune way to try to make some extra cash to make ends meet. Even though the success rate of day trading is extremely low, a rising number of people are taking advantage of their extra time to try to squeeze out a living.
There are several reasons day trading is just about the worst possible way you can try to make money in the market -- and why long-term investing is the better alternative. Before going into them, though, let's first look at the argument day trading fans are giving right now for why their way is best.
What day traders think about the coronavirus crash
Day traders point to market downturns such as the coronavirus crash as evidence that long-term investing just doesn't work. They argue that buy-and-hold investors are willing to see all of their profits disappear without any risk management. By contrast, day traders have to keep risk in mind all the time, limiting their trades and setting acceptable loss levels in order to avoid getting completely wiped out.
Indeed, there are many investing professionals who follow day-trading strategies, offering their services to customers and getting subscribers to pay recurring -- and sometimes costly -- subscription fees. Issuing trading alerts consistently through the day, these day-trading pros have an extremely short-term approach, seeking to capture profits from stock-price moves that last minutes or hours. Most day traders can trade on either side of the market, choosing to bet on a stock either rising or falling. That's a choice many long-term investors choose not to make, and it can make day traders look especially good during bear markets.
Why day trading becomes an epic fail for so many investors
Unfortunately, the track record for day trading leaves a lot to be desired. Consider some of the problems day traders run into in the course of their daily trading activity:
- A lousy batting average. Only about one in eight day traders makes money in any given year, according to academic research. When it comes to consistently making money year in and year out, the number of success stories falls to less than one in 100.
- Tax disadvantages. Even if you're fortunate enough to profit from a day trade, you'll end up paying short-term capital gains tax at your regular income tax rate. Compare that with long-term holdings of more than a year, on which gains get taxed at preferential rates as low as 0%.
- Trading costs. Many day traders assume that now that many brokerage companies -- including big ones like Schwab (NYSE:SCHW), TD Ameritrade, Fidelity, and Vanguard -- no longer charge commissions on stock trades, it must be cost-free to buy and sell in short order. However, market makers who take traders' orders typically offer less to buy shares than they charge to sell shares to you. That bid-ask spread isn't a big deal for long-term investors who trade occasionally, but it adds up quickly for frequent traders.
- An easy target for professionals. When you day trade, you're going up against Wall Street companies with immense resources and technology to play the same game you're playing. They're simply better at it than you are, and they'll take advantage of you any chance they get.
Most importantly, day traders will never capture the huge long-term return potential of the stocks they own. It's true that their downside might be limited compared to a long-term investor's during a bear market. But rather than enjoying their shares doubling, tripling, or even rising 10 times or more over the years, they have to stick with squeezing out a few dollars in profit over and over again -- all while risking financial ruin if they get something wrong.
Invest a better way
Day trading might seem like a great way to try to turn your free time into short-term riches. A few will beat the odds, but for the majority of those trying to day trade stocks, the results will be disastrous. The better option is to get through the financial challenges you face right now, and then look for great buy-and-hold stock picks that will help you find lasting financial independence in the long run.