It’s the question at the tip of every aspiring day trader’s tongue: how much money can I earn from day trading?
Since most day traders do not disclose their trading results to anyone but the tax authorities, an exact answer to how much money an average day trader makes is impossible to answer. However, there are numerous sources of information, including reliable academic studies, that offer clues on average earnings. The majority of available information does not shed a positive light on day trading. The research typically indicates that, in fact, most day traders lose money.
Day traders make money by buying stock and holding it for a short period of time–anywhere from a few minutes to a few hours–before selling it off again. Day traders usually enter and exit trading positions within the day and rarely hold positions over night. The focus is on profiting from short-term price fluctuations. They often use leverage to give themselves greater power to buy and sell.
Significant Start Up Costs
Getting started in day trading is not like dabbling in investing. Anybody would-be investor with a few hundred dollars can buy some stock in a company they believe in and keep it for years. Under FINRA rules, pattern day traders in the equities market must maintain a minimum of $25,000 in their accounts and will be denied access to the markets if the balance drops below that level. This means day traders must have enough capital on top of that to realistically make a profit. And because day trading is more than a full-time job, it is not compatible with keeping a day job. That means the day trader must live off his profits from trading as well as risk his own capital every day to make those profits. In addition to the minimum balance required, prospective day traders must consider the cost of equipment such as computer hardware and fast internet access. Brokerage commissions and taxes on short-term capital gains can also make a big dent in profits.
A University of California, Davis study published in 2000 by Brad Barber and Terrance Odean titled “Trading Is Hazardous to Your Wealth,” showed a correlation between active trading and poor performance among individual investors. The study pointed to overconfidence as a cause of high-volume trading and the resulting poor performance.
A 2004 academic study by Brad Barber, Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean examined the transaction history of the Taiwan Stock Exchange from 1995 through 1999. Day trading among individual investors is common in Taiwan and accounted for over 20 percent of total trading volume during the period of the study. The research showed that while high-volume traders were sometimes able to earn gross profits, the profits were usually not enough to cover transaction costs. In a typical six-month period more than 80 percent of day traders lost money, and only 1 percent of them could be called predictably profitable.
An important factor that can influence earnings potential and career longevity is whether you day trade independently or for an institution such as a bank or hedge fund. Traders working at an institution have the benefit of not risking their own money. They are also typically far better capitalized and have access to advantageous information and tools. Unlike independent day traders, they are also compensated with benefits such as health insurance, retirement funds, sick leave, and vacation days.
In 2012, the Wall Street Journal published an article giving some rare insight into the failure rates of retail foreign-exchange traders, many of whom are day traders. The article, titled “The Customer Is Too Often Wrong at FXCM,” showed that in four consecutive quarters more than 70 percent of FXCM’s U.S. accounts were unprofitable. The article cited the high levels of leverage available at FXCM (50 to 1) as part of the problem. With 50 to 1 leverage, a $10,000 account can take a market exposure of $500,000 and it only takes a relatively small adverse price move to erase the initial balance. Transaction fees are also mentioned as a hurdle that must be overcome.
Trying to become a millionaire through independent day trading is something like trying to become a Hollywood star or a professional athlete. The evidence suggests that a very small minority will achieve consistently high-level of earnings while the majority will not be able to sustain a long-term career.
Dan Blystone can be contacted at TradersLog