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The dangers of the day trade

Day trading is the practice of buying and selling financial instruments within the same day with the expectation of making quick profits on rising and falling prices. Typically positions are exited before the markets close as to reduce the risk of holding a position overnight, as the open price may have significantly changed from the previous day’s closing price. The financial instruments popular amongst day traders are stocks, options, currencies and futures contracts.

Day trading can be extremely profitable, however it carries significant risk, and day traders can just as easily suffer severe losses, or worse. While some professional investors are able to making a living from day trading, studies have proven that 70 percent to 80 percent of day traders lose money. Unlike a buy and hold strategy, day trading is not considered investing, it has been described by some experts as compulsive gambling.

Among the factors that gave rise to day trading were the gradual reduction in commission rates, the contraction of settlement periods, and the evolution of electronic communication networks which bypass exchanges and tend to offer favourable prices, near-instantaneous trading, and more economical commissions. The technology bubble and series of bull markets over 25 years also contributed to the increase in day traders. However the burst bubble, severe market drop during the financial crisis, and more stringent regulatory oversight and rules has generally limited day trading to a larger percentage of experienced professionals.

Professional day traders are generally very knowledgeable and experienced in how the market works. They generally require a large amount of capital to benefit effectively on intra-day price movements.

Typically, day traders use financial leverage and trade on margin, borrowing monies from their broker to amplify their trading positions and potential profits. Margin interest is usually charged on overnight balances, thus the trader is able to use capital without cost. However there is a risk of a margin call should the position go against the trader.

A fundamental tenet in day trading is to use only risk capital, the amount that the trader can afford to lose. A strategy and rules with the discipline to follow them, especially under pressure situations, is a characteristic of professional day traders. “Plan the trade” and “trade the plan” is a well-known saying. There are several basic techniques used by day traders. Range trading is identifying stocks that have been rising off their support price and falling off their resistance price and buying when the stock hits support and selling when it hits resistance. Trend following assumes that financial instruments which have been rising steadily will continue to rise, and vice versa when falling. Financial instruments trending up are purchased and those trending down are sold short in expectation that the trend will continue.

On the flip-side contrarian investing, a market-timing strategy, assumes a trends will reverse and the trader will buy an instrument that is falling and short sell one that is rising. News playing involves buying stocks which have announced good news and selling short those that have announced bad news. Scalping is a trading style that exploits price gaps created by the bid-offer spread.

Day trading is an extremely stressful and expensive full time job. While it is easy to be seduced by the potential of high profits, the statistics are evidence that 80 percent will fail, and is best left to the professionals.

Anthony Galliano is the chief executive of Cambodian Investment Management.
anthonygalliano@covenantim.com

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