Day Trading – Some Thoughts and Observations

My interest in day trading began about the time of the introduction of the S&P 500 futures contract. Over the years I have struggled with many of the pitfalls in day trading. I have had periods of success and periods of failure. I have also gone through long periods of inaction when I focused more on swing and position trading. But day trading still has many benefits, and there is certainly a lure that keeps pulling me back to try again and again.

Day trading earned a much-deserved negative reputation during the Nasdaq bubble in the late 1990′s. Then you could find many day trading schools and trading rooms that tried to make day trading look like easy money, mostly with video arcade style trading applied to Nasdaq stocks. Most of those rooms and methods are now gone. But replacing the Nasdaq day traders are a new crop of on-line trading rooms and trading schools that focus on stock index futures and forex.

Among the investing establishment, day trading certainly has a negative reputation. When I am in a debate with a typical investor I hear comments such as: “I’ve never met a day trader that made any money. The costs of commissions and data eat up any profits. Day traders are chained to their computers all day while I’m at the golf course. And of course, the really big money is made in the long term and day traders miss all those big trends.”

These are all good points. I’ll take them one at a time. Of course most people I meet near where I live have never met a day trader that made any money. I live far away from the pits and trading floors in New York and Chicago. Most of the traders on the floors of the pits and exchanges are in fact trading in and out of the markets all day long. The are day trading. They are creating liquidity in the markets. They insure that the spread between contract months is in line and liquid. They are there to take the other side of the retail paper that comes into the market. The markets could not exits without the day traders who are professional and make their full time living from the small, numerous trades and small profits they take out of the markets. These professionals are not normal the traders thought of when the debate comes up about day trading. But these are part of the mix of traders that the new crop of at home screen based day traders are competing against. The screen based day traders also contribute to liquidity, and depending on market, are replacing or supplementing the pit trader.

Are transaction costs and equipment a detriment? It was difficult to overcome transaction costs just a few years ago if you were an off the floor trader. Today commissions are practically negligible, and some of the best charting and data packages are essentially free with a minimum of trading activity.

And what about being chained to a computer all day, while your friends are out playing golf. It is true that to make money day trading one has to monitor the market during the trading day. I guess one could also say that to be a surgeon one has to spend some time at the hospital, and if you were a baseball player you would have to spend some time at the baseball field. It is hard to comment much further if anyone is going to criticize someone’s career for actually having to be there while working at it.

Day traders certainly do miss some of the big moves. However, the big moves are rare. More common is the daily up and down pulsation of the market, and day traders are able to capture many up and down swings during the day, while the longer time frame trader has to sit through seemingly endless back and forth chop. In fact, markets spend most of their time trying to find trend direction, with much of that time spent in sideways patterns that make it difficult to make money on a position trade basis. Also, what information does the longer-term trader have to suggest a profit in that time frame? The day trader can more easily see what is there and what is happening right now. It is much more difficult to look out into the future and to make an assessment of what conditions might prevail a year or two out. A day trader doesn’t rely on information disseminated by an analyst. He merely trades what is in front of him. He trades what he sees; not what he is fed by outside, non-market-generated information that may be questionable.

And what about the really big, wealth building kind of money that is the objective of the very long-term investor. Warren Buffett has made some really big money, and he is about the longest-term investor you could use as an example. I’m quite sure he wouldn’t advise day trading. Of course his ability to place large trades is made much easier because day traders are doing their job. It is true that in the very long term, if you are very good at seeing the big picture mega-trends, and use the power of compounding, truly spectacular gains can be had in the very long-term time frame. But even Mr. Buffett has a difficult time maintaining his own track record. Very few portfolio managers can keep up with the broad-based indexes for more than a year or two, let along better them. But the very long term does take advantage of the overall bullish trend of stocks over long periods of time. The same cannot be said for commodities, although to some degree they can keep up with inflation. While short-term day trading can be stressful, long-term investing can try your patience. Can you sit through twelve or more years of no returns or even negative returns? That can happen to the long time frame investor. The market may have long stretches of sideways movement, but the day trader still has the opportunity of many up and down trends available nearly every day.

There are some additional points to consider before considering day trading. It should be obvious, but some people just cannot make decisions quickly enough to day trade. Some people require more information and confirmation by looking at many indicators. With day trading, there just isn’t the luxury of time to consult with many indicators, especially if a very short time frame is being used. It is better to use few or no indicators. A certain amount of intuition about the market you trade will in time, with enough experience, begin to emerge, which may take the place of looking at many indicators.

For many the biggest obstacle to day trading is the stress level. Concentration often must be maintained for long period of time during sometimes inhospitable market conditions. The stress level can be magnified as the time frame shortens.

One point I want to stress about stress, and should be considered carefully, is the dependence on the technology working. Stress can be intense while in a trade if the equipment and technology break down. You can have a backup computer, a backup high speed internet connection, a backup power supply, and backup brokerage accounts. Even with everything backed up, the exchange order entry or data feed can go down at just the wrong time. With electronically traded contracts the only thing that can be done is to try to hedge in a similar market, if one is available. Even when all the technology seems to be working, there can be deceptive delays in data during sudden fast market conditions that can introduce slippage that wasn’t apparent during testing. I experienced many of these technological problems during July and August of this year (2007). My cable internet provider changed some equipment in their system, and I started getting booted many times every morning. I had DSL as a backup, but the time it took to switch over was too long. It took nearly a dozen service calls to the cable provider to finally fix (I hope) the problem. Just the other day the exchange I mostly trade on was down for most of the session. Fortunately I had no position on. During that long outage the market made a huge move that would have created a huge loss if I had been on the wrong side of the move and not able to exit. Both the futures accounts I use experienced several outages on their end during these weeks, lasting from minutes to an hour or more. Also, fast market conditions appeared more often than ever, with the data being presented on the charts being far different than the actual bid and ask prices presented on the order entry platforms. I often see this briefly on Fed report days, but this was occurring regularly, and for extended periods of time during this summer. These problems would be minor if I were swing trading off of daily or 60-minute charts, and would not be a problem at all if I were an investor. But if you are trading off of very short-term tick charts, a data outage or other technological problems can really ruin your day.

After having traded in many time frames and trading styles, I think the most important issue is to find a trading style that fits the personality of the trader, and not rule out day trading because of misconceptions. There is not a right or wrong answer to the question of the feasibility of day trading. But it must suit the individual trader. For some traders long term investing is totally wrong, and day trading is a better fit. One will only know after trying, and keeping realistic expectations in mind. Also, I think it is a good idea to stay out of the crowd and chose a time frame very short or very long. It is difficult to take profits from the market if you are looking at the same information as the masses. Often either a day trading approach or a very long-term approach will prove to be a less beaten path. The most important piece of advice I can suggest it to stay away from day trading chat rooms and trading schools, that usually present day trading to be an easy path to trading success. Day trading will most likely be the most difficult path you could possibly choose.

I will add to this article as new thoughts and ideas appear to me. Many of the articles on indicators on this blog deal with day trading. Please feel free to add your comments to this article.

6 thoughts on “Day Trading – Some Thoughts and Observations

  1. howdy Doug………….havnt been to bellevue as ive been on the road latlely………….nice website…………ive had strategy runner go down on occassion while in a trade………..stops and targets remains on there servers just something to consider……………..hope to come up north this summer…………….kc

  2. Nice balanced view of daytrading. More accurate than either the “all day traders lose” camp or the “daytrading is easy money” brigade.

  3. bolang, In my opinion Market Profile is the most useful tool, but there is a long learning curve. But then again there is a long learning curve to most things that are worthwhile. I think most indicators have limited value if price structure is not well understood. I’d stay away from chat rooms and so called educators and instead try to learn how to listen to what the market is trying to communicate.

  4. Day trading is manipulative game creating false gyrations and trapping who think they know chart reading.Text book charts are created then flies are killed.Catch your ears seven times never to go for day trading positional trading is safe and best.

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