Day trading may be more tempting but don’t throw caution to the wind

Most studies show that investors engaged in day trading – who try to take advantage of short-term volatility in stocks or other assets – lose money and could reap bigger gains by hanging on to a low-cost index fund that tracks the general stock market.

But tell that to the millions of bored, stuck-at-home investors who think they know how to beat the market. Retail investors accounted for 18.5 per cent of US stock-trading volume as of April, compared with 15 per cent a year earlier, according to Larry Tabb, head of Market Structure Research for Bloomberg Intelligence.

Since many will not be dissuaded, I thought it would be helpful to speak to some experienced professional day traders to offer practical tips.

Do not forget that success stories are rare. Fewer than 1 per cent of day traders can predictably and reliably do better than benchmark indexes, according to a study of day traders in Taiwan by Brad Barber, a finance professor at the University of California at Davis, and others.

First, potential investors need to choose a trading style and stick to it. Some are fast enough to capitalise on volatility within seconds. Not all are patient enough to hold a position for a few hours. Some are comfortable with smaller, more frequent gains or losses, while others feel better with fewer, larger ones. There is a choice to be made about whether to trade a handful of stocks, or to focus on broader sectors or move towards anything that is experiencing large price swings. Investors who restrict themselves to one or two stocks may be more apt to make trades when there isn’t actually a good reason to do so.

Trading styles will determine which trading website or app is most appropriate and the trading communities most appealing. For example, using the Robinhood app on an iPhone may not work for a trader looking to execute hundreds of trades within seconds. (Because Robinhood is not a direct-access broker, trades may be executed more slowly.)

Many websites offer simulated trading, which experts suggest using for at least three months before investing real money, and some even offer the ability to watch seasoned traders at work and ask them questions.

It is also important to establish financial goals, which will influence how much money is allotted to a trading account. Sarah Potter, chief education officer at the trading website TradeStation and author of How You Can Trade Like a Pro, says she started out day trading to pay for “extras”. Her personal rule of thumb is never to risk more than 5 per cent of her account per trade.

For more casual investors who are not looking to make trading their full-time jobs, the professionals said that it is still a lot of hard work, and crucial to consistently track whatever you trade.

Look for volatile stocks with a lot of volume so they can be easily traded. Over the past few months, sectors of interest have included pharmaceuticals, airlines and entertainment, given how much they have been affected by the coronavirus pandemic. Technology and semiconductor stocks have also drawn attention.

It is never smart to trade on instinct, but rather to base trades on tangible evidence such as weekly charts showing price movement. An options contract to buy or sell at a preset price by a certain date keeps excessive optimism and pessimism under control. Another useful strategy to hedge against risk is to trade two stocks that are moving against each other, such as those involved in a merger arbitrage deal.

A novice who makes a lot of money is in grave danger of making mistakes of overconfidence later. Social media addicts are unlikely to profit by following the crowd.

Finally, investors should keep a meticulous record of profits and losses. That is the only way to know the difference between individual success and market trends.

It is never smart to trade on instinct, but rather to base trades on tangible evidence such as weekly price movement charts