According to an academic study of day traders in Taiwan, the combined overall performance of day traders is negative. The vast majority of day traders are unprofitable, and many traders persist in trading for years despite their losses.
It is estimated that 80% of day traders quit within the first two years, and nearly 40% quit within one month. After three years, only 13% remain, and after five years, only 7% remain. The average individual investor underperforms the market by 1.5% per year, while active day traders underperform by 6.5% annually.
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Based on these statistics it is no surprise that the conventional wisdom is that it is foolish to be an active trader. Why should anyone even attempt active trading when the odds appear to be so heavily stacked against them?
The answer is that there are some skilled traders who consistently do well over a long period of time. It isn’t just a matter of luck. It is possible to learn how to trade effectively and to make good money doing it. Day traders with strong past performance tend to earn strong returns in the future. Once the skill of trading is developed then it can be maintained. What does this small group of traders do differently than what the average day trader does?
The Biggest Reason Most Day Traders Fail
The biggest reason most day traders fail is that they really aren’t traders; they are gamblers. Day trading largely attracts individuals with a gambling mindset. In Taiwan, day trading dropped by 25% when a lottery was introduced in April 2002. When there is a large lottery jackpot, day trading activity declines. Many day traders with a gambling mindset have moved to cryptos and have lost even more money even faster.
The less capital a trader has, the more likely they are to take extreme risks. Poor individuals spend a greater proportion of their income on lottery tickets, and demand for lottery tickets increases as income declines. The same dynamic applies to day trading. The more capital declines, the greater the likelihood of taking on more risk.
Day trading is sometimes portrayed as an effective way to reduce risk because positions are not exposed to unknown overnight events, which eliminates some uncertainty. However, there is a tendency to ignore how much risk is created by routine intraday volatility.
Typically, day traders are working with lower levels of capital, and that leads to very concentrated positions and much higher risk. Just a few bad traders will cause a substantial drawdown in capital. When this occurs, many traders take on even more risk to try to recoup losses and get back to even.
Another problem is that market conditions shift wildly. In each market cycle, there are periods of time when aggressive short-term speculation works much better, but then there are much longer periods of time when it doesn’t work nearly as well. Most unsophisticated small traders are incapable of shifting their trading style to accommodate the differences in market conditions. They use the exact same methods even when they are no longer working.
3 Steps to Be Successful at Very Short-Term Trading
1. Develop a speculative mindset rather than a gambling mindset. The biggest problem with a gambling mindset is the desire for an immediate payoff. There is a tendency to take big risks for an immediate return and to focus on the potential for good luck rather than skill. Every day, there is a huge amount of capital chasing small stocks with the most volatile.
There is enough luck involved in the process to make traders think that they are skillful in their trading, but over time, bad luck and poor capital management will wipe them out. Most small traders bet too much capital on high-risk trades.
Traders with a speculative mindset are much more aware of risk and actively find ways to keep it contained. The most important thing a trader must do is protect capital, and that can only be done by controlling risk.
2.Manage capital carefully. The less capital you have to work with, the greater the chances you will fail as an active trader. When capital levels are small, there is less diversification and less consideration of risk.
3.Use a variety of time frames. One of the main reasons that very short-term trades fail isn’t because their strategies or stock picks are bad but because the time frame is too short. Stocks move very erratically and randomly in the short term, and using five-minute charts gives a false illusion of precision.
The best trades need some time to work, and if you are impatient, the odds of failure greatly increase. If your time frames are inflexible, then there is a much greater chance that your trades will fail.
Aggressive short-term trading is extremely difficult, and most people will fail at it. That is why it is so potentially lucrative. If trading was easy, then you would not be able to produce substantial profits. If you work hard at it, trading can produce a steady income for the rest of your life.
At the time of publication, James "Rev Shark" DePorre had no position in the securities mentioned.
