Why day trading is not the way to invest
Created on 06 Jul 2020
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Updated on 08 Oct 2020
When discussing the investment portfolio of Berkshire Hathaway in 1996, Warren Buffett, in a letter to the shareholders, said, "Our portfolio shows little change: We continue to make more money when snoring than when active."
The CEO of Berkshire Hathaway says that given favorable long-term prospects, his favorite holding period would be forever. Buffet, who is a staunch advocate of value investing, believes in finding stocks of companies that are fundamentally strong and have good prospects and then holding those stocks for an extended period. However, many people chose to do otherwise.
Different people have different ways of investing in the stock market, and their style of trading depends on a variety of factors that range from their willingness and ability to take a risk, the time that can be invested by them, trading costs and the amount of capital that they are ready to invest.
Why day trading is not the way to invest
Many times, day trading seems like a very attractive option, especially when someone is just starting in the stock market. However, it may not always be the case, and the reality could be very different from what is shown in the movies and on the web. Day trading is when one buys and sells stocks within a single trading day. It involves holding the stocks for a few hours or a few minutes. Some people even hold it for a few seconds. This is done to take advantage of any short-term fluctuations that may take place in the stock market during that particular trading day. On the other hand, long-term investing involves buying a stock and keeping it in that position for months or even years. This is also known as the 'buy and hold' strategy where long term return is preferred rather than short term gains.
What one needs to understand before starting with investing is what kind of investing style would be best suited for them. Both styles require different strategies and different time commitments. When we look at day trading, it is more of an active style of trading where investors try to make quick decisions to profit on short term fluctuations. When day trading, one needs to constantly monitor the market for any changes, and they have to develop a system to be active when the markets are open.
This could serve to be a severe challenge for some, especially if one is operating in the global markets as the different time zones result in the different market open times for different markets. For example, the Indian market and the European markets open at different times, and to make maximum profits; one has to be active when the market opens. On the other hand, long term investing is a more passive style of investing, and it does not require a lot of time commitment as one can monitor the investments held on a monthly or yearly basis.
Another problem with day trading is that it could result in a lot of costs to the investor. Someone who is both buying and selling several stocks in a single day would have to pay commissions on all those trades even if he/she is making a loss on that trade. These transactions result in a lot of costs like Security Transaction Tax, Brokerage, GST on brokerage, stamp duty, etc., which could sum up to a huge amount for the trader.
Then the trader would have to be able to make higher profits as well to break-even. Also, day trading could result in the trader paying a lot of taxes. Profits on day trading are classified as speculative profit or loss. Specified profit or loss comes under the Income Head of Business and Profession of income tax, and so it is taxed at the normal rates of taxation. A way of reducing our taxes would be to make investments as then the returns would come under a short term or long-term capital gains, which are usually taxed at a lower rate. While trading intraday, one also needs to consider the different legal requirements involved. There is a minimum capital requirement for such trading, and the margin is also required to be paid.
Another factor that could act as a deterrent for day trading would be the investor's risk appetite. Day trading involves quite a lot of risk, and one decision could either result in a lot of profits being earned, or it could result in the trader losing huge amounts of money. Day trading is very much like a gamble with high stakes involved, and that is the reason why many experts do not suggest it to someone who is just starting out or to someone who is risk-averse.
Trading intraday is also based on technical analysis rather than fundamental analysis, and it is based on a lot of speculation, which could prove to be risky. Someone who does not have the willingness or the ability to take that kind of risk should probably look at long term investing as it is a more passive strategy. Long-term investing gives the investor time to think about their decisions by evaluating the companies and buying them at the right price so that they are confident that their action is correct and the stock's value will increase in the future.
When we look at day trading to make huge profits, traders even have to invest a lot into that trade, and by investing, we do not just mean capital investing. A lot of investment is also required to get the right training to trade professionally. Apart from that, investment also has to be made to acquire the right software and the right hardware so that one can find the right opportunities and act on those opportunities very quickly. Subscribing to such software, hardware, and news services can become very expensive for a regular investor or a beginner.
When starting, many traders do not have enough experience and lack the relevant skill set required to make profits in day trading. They are not aware of all the tricks and traps that are present and may falter along the line, thus losing a lot of money and getting discouraged to invest further. As human beings, we are also prone to a lot of behavioral and psychological biases that make this process even more difficult. We might hold on to losers too long or may sell off the winners too quickly.
Due to these reasons, we feel that day trading is not the way to invest. However, even after so many disadvantages, this process also has pros, and someone who wants to try day trading should get the relevant knowledge and understanding before doing so. To get this knowledge, one can talk to someone who trades in this manner or talk to experts, read articles, and research properly. They could also look at paper-trading for some time where one can create a hypothetical account without actually investing any real money.
Nowadays, we also have a lot of applications that allow their users to create an account where they can use the practice mode and use the stock market simulators to track their hypothetical positions. And if day trading is not something that one thinks is suitable for them, then they can always try long term investing by holding a well-diversified portfolio, which would be a safer bet. Furthermore, Warren Buffett, one of the richest men, is following this, so why shouldn't we?
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