Day trading can be hard to resist. The fast-paced action, the instant gratification, and all those tales you've heard of people getting rich from minute-by-minute stock trades can all be potent lures. Unfortunately, the hard evidence suggests that most day traders end up deep in the red.
A few years ago, well-respected researchers Brad Barber and Terrance Odean teamed up with a Taiwanese team to study day trading in the active Taiwan stock market. They found that day traders were responsible for more than 20% of total volume in the market. (Earlier estimates suggest that day traders have generated around 15% of Nasdaq volume in the past.)
According to Barber and Odean, "Heavy day traders earn gross profits, but their profits are not sufficient to cover transaction costs" such as trading commissions. In starker terms, "in the typical six-month period, more than eight out of 10 day traders lose money."
A risky proposition
The researchers did find that a rather small segment of day traders do earn real profits -- but there's no guarantee that you'd be in that group if you followed suit.
According to a 2003 research paper that studied day-trading activity, 36% of traders earned a net profit ($197,000 for the most successful one), while 64% lost money ($748,000 for the least successful one). Only 20% managed to net at least $5,000.
In short, day trading involves considerable effort and huge risks, all in exchange for the overwhelming chance that you'll lose money, or score a slim gain at best. Long-term buy-and-hold investing isn't nearly as exciting, but its rewards can be far greater.
To illustrate, I've rounded up the 20-year performance of several well-known stock names, most of which would have boosted your wealth considerably with far less risk:
|
Company |
CAPS Rating (out of 5) |
20-Year Avg. Annual Return |
$10,000 Would Turn Into |
|---|---|---|---|
|
Texas Instruments (NYSE: TXN) |
**** |
14.3% |
$145,700 |
|
Pfizer (NYSE: PFE) |
**** |
12.9% |
$113,400 |
|
Deere (NYSE: DE) |
**** |
12.9% |
$112,300 |
|
ConocoPhillips (NYSE: COP) |
***** |
10.6% |
$74,300 |
|
3M (NYSE: MMM) |
**** |
10.3% |
$71,400 |
|
IBM (NYSE: IBM) |
**** |
9.9% |
$66,000 |
|
Disney (NYSE: DIS) |
**** |
7.5% |
$42,800 |
|
Eastman Kodak |
* |
(5.1%) |
$3,500 |
Data: Yahoo! Finance, Motley Fool CAPS.
As the table shows, you can fare far better seeking solid, long-term performances than chancy short-term gains. The best investors trade not over days, but over decades.
Are you a day-trading die-hard? Is buy and hold the only way to go? Share your opinion in the comment box below.
