Can you read and write? Count backwards from 10, and remember your birthday? Most important of all, are you crazy?
If you can answer "yes" to all three questions, "day trading" just might be for you.
Day trading is back, baby!
According to the Wall Street Journal, as the stock market bounced back from last year's March lows, the day trading phenomenon bounced back along with it. Surveying data from the dog-days of trading -- August, when many investors are on vacation and trading volumes traditionally sag -- the Journal observed that trading volume spiked 14% at major online brokerage firms.
As we'll see in a moment, that's horrible news ... for day traders.
Bargains abound ...
2009 was a great year to invest in stocks. At the Fool's own Motley Fool Stock Advisor service, we highlighted compelling opportunities in the shares of Ford (NYSE: F), Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), and Disney (NYSE: DIS), to name just a few (and we continue to believe in them!). All of these stocks are up strongly, and beating the market soundly.
But there was also an awful lot of junk getting traded back and forth in 2009. As leading financial companies like Citigroup (NYSE: C), Bank of America (NYSE: BAC), Fannie Mae, Freddie Mac, and AIG (NYSE: AIG) approached penny-stock prices, day traders flocked back to the market. Shares in those beaten-up financials constituted as much as 20% of total market volume in August 2009.
... and danger, too
Problem is, as Fool CEO Tom Gardner once told Congress, investing in "penny stocks ... recreates the thrill of a gambling casino, where fortunes can be won in an instant -- yet where fortunes are clearly lost over the long haul."
A lot of day traders hit the jackpot last year, and bully for them. But the problem is ... even now that they've profited mightily, they may not be able to walk away winners.
According to a recent study published by researchers at the University of Pisa, gamblers often suffer from "impulsive, compulsive, addictive behaviours." Using 20 patients undergoing treatment for pathological gambling disorder at an Italian clinic as their sample, the scientists tested patients' ability to modify their behavior in response to changed circumstances.
Patients were asked to play a "card-matching" game under one set of rules initially. But "after 10 cards have been selected correctly in one category, the interviewer changes the category without informing the subject and from that moment on, answers which would have been correct for the previous category are considered wrong. The subjects have to change the principles according to which they pair off the cards in order to discover the new category chosen by the interviewer."
So how do you think these compulsive gamblers fared under these changed circumstances? Did they roll with the punches, figure out the new "angle," and keep on winning? Sadly, no. They couldn't hack it. Gamblers who exhibited "normal intellectual, linguistic and visual-spatial abilities" in all other respects were found to:
- Suffer from "impairment of decision-making"
- "Make choices according to an immediate reward, despite being fully aware of the long-term negative consequences"
As a result, they proved incapable of learning how to play the game once the rules changed. They stuck to the pattern they knew, regardless of the consequences.
The definition of insanity
Once upon a time, Albert Einstein defined insanity as "doing the same thing over and over again and expecting different results." That's exactly what these gamblers were doing.
And it seems the same problems plaguing compulsive gamblers also afflict day traders. You see, Tom isn't the only one making a "casino" analogy to day trading. Fool member Jeff Nazdek agreed to share with us his experiences as a "professional" day trader:
Online trading ... can become an addiction, and the cyber-world can become a substitute for work and family. You may come to feel that you can't be away from your computer monitor for 10 minutes or you will miss a hot stock or your position may downtick. ... If you make a bad trade or fall behind in a position, you might "double up" ... trying to make it back all at once. These are the same symptoms of compulsive gambling and are very easy to fall into.
What that means, I fear, is that the same investors who profited from trading into and out of low-quality stocks last year may repeat this risky behavior in 2010 (and beyond) -- but with significantly worse results.
The fact that stocks once priced for bankruptcy now sport nosebleed valuations and no margin of safety won't worry them. They'll likewise scoff at the risk of interest rates rising or the U.S. dollar devaluing. Nor will they notice that a government that once ran printing presses night and day to provide the funds necessary to keep banks out of trouble may not be able to continue doing so.
Call it gambling. Call it insanity. Call it just plain stupid -- the results will be the same. People will lose money.
How not to lose money
Here's another note from Jeff:
After one full year of online day trading, I've come to an important conclusion: it is not as profitable as investing for the longer term, at least for me. After carefully analyzing my hundreds of trades and monthly statements, it was apparent that several "buy and holds" ... this spring accounted for the bulk of my profits, while the day trades whittled away at those gains, slowly but surely. Like gambling, the odds are stacked against you, and the more you play, the more you lose.
I couldn't have said it better myself.
So please, approach investing stocks from the perspective of a long-term investor rather than a gambler. Your wallet will thank you.
If you'd like some help choosing more great stocks to buy for the long term, you can get the latest stock ideas from Fool co-founders Tom and Dave Gardner at Stock Advisor. Their focus on investing for the long haul works – their picks are currently beating the market by more than 51 percentage points. Thirty-day trials are available on demand -- and absolutely free. Click here to see what stocks they're recommending right now.
Fool contributor Rich Smith does not own shares of any company named above. Berkshire, Ford, and Disney are Stock Advisor recommendations. Berkshire and Disney are Inside Value picks. The Fool owns shares of Berkshire. The Motley Fool's disclosure policy has no preexisting conditions.
