Why Day Trading is a stupid thing to do
This is going to be a short post and will explain why Day Trading is a stupid thing to do. Really really very stupid. No other word. Stupid is the most polite word there is to describe it.
Lets check out below case study.
On 27th October 2006, Sensex opened at 12741.85 and on 18th November 2015, it closed at 25482.52. So Sensex doubled in a little more 9 years (total of 2245 trading days). On a Daily Basis, the Sensex increased by about 0.03% from previous close to next close. This is where things turn ugly for Day Traders. Let us split this 0.03% everyday return into two phases.
- From previous close to next open, and
- From next open to next close.
Which of above two is the better time to invest? The answer obviously depends on how much return these two phases individually gave. To illustrate, let’s take a scenario of 3 brothers.
One just bought into sensex on 27th October 2006 Open and went about his life. He got double his money on 18th November 2015. Not spectacular returns by any means, barely 8% CAGR but not bad, considering that he didn’t spend any time on this.
Second used to buy into sensex everyday at Close of the day and used to sell it on the Open next day. All proceeds were re-invested at the close and so on for 9 years. In this duration, from close to next open, the index went up by about 0.12% everyday on an average. He would get 15.65 times his investment, a very handsome CAGR of 35.5%. (Obviously we are assuming a no tax, no brokerage ideal world)
Third did it other way around. He bought at Day’s Open and sold at Close, only to buy it again at next Open. However from Open to Close, the sensex went down by about 0.09% everyday on an average. His investment will become 0.12 times of original amount, a nightmarish CAGR of -20.3%.
Please feel free to check out the attached excel for the details of the calculations.
The Day Trader happens to be that third brother. He is doomed to fail. And as if this is not enough, here are some more problems
- Higher Brokerage Cost – Obviously the rate is low but the amount of brokerage Day Traders pay is usually a lot higher than investors
- Higher Tax – Day Trading income (If at all, there is any) is considered to be Speculative and is usually taxed at higher rate than Short Term Capital Gains
- Higher Time/Effort spent – Obviously it takes a lot lesser time and effort to invest. The Day Trader has to keep looking at the computer screen all day and raise his BP.
So, to summarize our inferences,
- Stock markets (at least in India) seem to go 3 steps up before Open and then go 2 steps down during the day, probably to correct its folly.
- The best time to own stocks is at night between the close and open. But obviously, it can only be utilized by someone who is already holding the shares in his portfolio.
- A Day trader is operating at a time when probability of stocks going up is worst. It is stupid to expect individual shares to go up consistently during the day when overall market is in red so often. It is like wanting to score a century but choosing Nagpur wicket of ongoing India vs. South Africa Test Match to bat on.
- There may be a reasonable case of shorting the shares as part of day trading. However considering the risks associated with shorting on top of above mentioned problems with Day Trading, even that may not be a very profitable decision.
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