Fueled in part by lockdown boredom, unexpected pandemic income, and commission-free brokerages (Robinhood), and then further juiced by an epic bull market and the rise of volatile cryptocurrency trading, day trading has seen a rise in popularity over the last few years. The internet is rife with influencers peddling their particular courses and video series, promising to unlock the secret to windfall profits from only a few hours of daily work.
This post looks at the available data, statistics, and financial literature on the feasibility of profitable day trading, and the results are awful. Almost all day traders lose lots of money, particularly after accounting for fees and taxes. Astonishingly few individuals are able to consistently profit over time, and those that do are extremely experienced and sophisticated -- not beginners.
Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investorsby ,and published in ,
The paper examines the performance of individual investors in the stock market and finds that, on average, individual investors underperform the market due to their overconfidence, lack of diversification, and tendency to sell winning stocks too soon while holding on to losing ones for too long. The authors sample 66,465 individual investor's trading records from 1991 to 1997. The study concludes that individual investors would have performed better if they had adopted a more passive investment strategy, such as investing in low-cost index funds, rather than attempting to beat the market through active stock picking. Additionally, investors who were more active (i.e., day traders) significantly underperformed the more passive investors.
- Individual traders tilt their investments toward small, high-beta stocks. There is a less obvious tilt toward value (high book-to-market) stocks.
- After fees and commissions, the average investor underperforms a value-weighted market index by about 9 basis points per month (or 1.1 percent annually).
- After accounting for the fact that the average investor tilts its common stock investments toward small value stocks with high market risk, the underperformance averages 31 basis points per month (or 3.7 percent annually)
- Of the ~66k traders, about 20% are considered 'active' in that they traded more than 48 times per year.
- Active traders underperformed the value-weighted market index by 86 basis points per month (or 10.3 percent annually).
The paper summarizes its findings somewhat brutally: (quote is edited for clarity)
Our main point is simple: Trading is hazardous to your wealth. Why then do investors trade so often? We believe that these high levels of trading can be at least partly explained by a simple behavioral bias: People are overconfident, and overconfidence leads to too much trading.
Based on rational agents free from such behavioral biases, the efficient markets hypothesis has been central to both the theory and practice of investment management. The efficiency research posits that private information is rare. Thus, active investment strategies will not outperform passive investment strategies. Both the theoretical and empirical work on efficiency supporting this view have led to a rise of passive investment strategies that simply buy and hold diversified portfolios.
Behavioral finance models that incorporate investor overconfidence provide an even stronger prediction: Active investment strategies will underperform passive investment strategies. Overconfident investors will overestimate the value of their private information, causing them to trade too actively and, consequently, to earn below-average returns. Consistent with these behavioral models of investor overconfidence, we provide empirical evidence that households, which hold about half of U.S. equities, trade too much, on average. Those who trade the most are hurt the most.
The Cross-Section of Speculator Skill: Evidence From Day Tradingby , , , and published in ,
This paper seeks to understand the differentiating factors between successful and unsuccessful day traders in Taiwan. The authors received comprehensive trading data from the Taiwan Stock Exchange from 1992 through 2006. They defined day trading as the purchase and sale of the same security, by the same individual, on the same day, which accounts for approximately 17% of the overall volume on the Taiwan Stock Exchange. On average there were 450,000 individual day traders during each year, of which about half (277,000) traded in amounts larger than $20,000 USD-equiv each day. The key findings were:
- Any given year, only about 19% of the heavy (>$20k per day) traders made positive abnormal returns (i.e., did better than the market) net of fees. That's 1 in 5.
- Only 4,000 individuals (less than 1% of the population of day traders) were able to consistently profit, net of fees.
- The top 500 traders of the 450,000 were remarkably consistent and generated outsized profits, earning net +37.9bps (0.379%) per day.
- The "bottom" 440,000 traders (the overwhelming majority of the 450,000 population) lost about 25-29bps per day.
- While the overwhelming majority of traders lost money - data showed a consistent trend that highly active day traders outperformed occasional day traders.
- Trader performance was statistically more consistent and non-independent than random luck would predict. That is, the profitable traders (of which there were exceedingly few) were not just getting lucky.
- Profitable day traders performed especially well trading few volatile stocks near earnings announcements - suggesting that the source of profits comes from their superior trading judgement and expertise in those stocks, and not from just providing liquidity to the market.
- Insider trading may be attributable to some of the profits, and cannot be ruled out, though the consistent profitability of the highest performing day traders, even outside of earnings announcement periods, suggests it is unlikely that insider knowledge is entirely the cause of their profits.
- The evidence suggests that profitable day traders "react more quickly to public information signals in their trading strategies" than the unsuccessful traders.
In conclusion, the paper finds strong evidence that day trading is consistently and highly profitable, even net of fees, to those with 1) the best information/strategies, 2) the best systems/access to trade quickly, and 3) the highest conviction/discipline. However, this accounts for fewer than 1% of all traders. In all likelihood, these are career professionals with great connections and highly sophisticated trading tools and systems. The overwhelming majority of day traders lost money, consistently, and worse than random luck would predict.
Learning, Fast or Slowby , , , and forthcoming in ,
This paper is by the same group above studying the same Taiwanese day trading data (all trading activity 1992-2006), this time trying to understand the motivations behind day traders and why they continue to engage in the activity. Interesting findings are:
- Around 1% of the adult Taiwanese population day traded in any average month.
- The average day trader traded on 43 days of the year.
- Aggregate net returns for all day traders (combined, not individually) was negative for every single year studied.
- Profitable day traders have a 96.4% probability to day trade again in the following 12 months. Unprofitable day traders have a 95.3% change to day trade again in the next 12 months. This shows that performance has a surprisingly tiny affect on future trading behavior.
- 74% of all day trading volume is attributable to traders with no history of success.
- On any given day, 97% of day traders lose money net of trading fees.
- This data suggests that new investors decide to begin day trading only because they are overconfident in their ability to be profitable at it
Perhaps these direct quotes from the paper summarize the findings best:
In aggregate, day trading is a losing proposition; day trading is an industry that consistently and reliably loses money. From an industrial organization perspective, it is difficult to understand how such an industry survives. For people to knowingly day trade, most must either be overconfident about their prospects of success or derive non-financial utility from the activity and knowingly suffer losses as a result.
Overconfident day traders may simply be bearing losses that they did not anticipate. While novice day traders undoubtedly realize that other day traders lose money, stories of successful day traders may circulate in non-representative proportions, thus giving the impression that success is more frequent than it is.
Day Trading for a Living?by , , and published on ,
This study is an analysis of all new day traders on the Brazilian equity futures market from 2012-2017. (Futures are particularly compelling for day traders in the USA as well, as they are highly liquid markets and exempt from particular PDT taxes that apply to day trading most other securities).
The distinction here of only using new day traders is interesting, since it very likely weeds out the highly sophisticated professionals referenced in the Barber study above. Rather, this study is probably a more realistic view of what an 'everyday' person can expect if they quit their day job and start day trading. Highlights and findings from the study:
- The study covers about 20,000 individual investors who began day trading in 2013, 2014, and 2015, defined as an investor who did not have any day trades in the prior calendar year.
- Returns clearly show that probability of being profitable goes down proportionally with the volume of trades made. That is, the most profitable cohort of day traders were those who only made a single day trade all year.
- Of the most active traders (1,500 of the 20,000 population), data shows performance did not improve over time. I.e., those individuals did not learn or improve their skills in subsequent trades.
- Of the most active traders (1,500 traders), only 17 individuals earned more than Brazilian minimum wage, net of fees.
Overall, the paper concludes:
... it is virtually impossible for an individual to day trade for a living, contrary to what brokerage specialists and course providers often claim.
The Profitability of Day Tradersby , and published in ,
This is a brief study done during the first internet bubble, when online brokerages gained popularity and day trading first because a viable option for regular people. The intent of the study was to determine the overall profitability of day trading in light of its contemporary rising popularity.
The researchers were able to study the trades of 324 day traders from February 1998 to October 1999. Note that this was a time period where the S&P500 gained 30%, and the Nasdaq was up over 100%. Findings and highlights:
- Of the 324 traders for whom they had data, 36% made a profit over the period of the study, while 64% made a loss.
- Only 20% of the traders in the study made more than $5,000 over the time period.
- Total commissions for each round-trip trade were $30. Researchers determined that on average (across all investors) day trades were profitable gross (pre-fees), but were negative net (after fees).
- Researchers found a statistically significant correlation between the performance of day traders and the price movement of the Nasdaq exchange, indicating that traders had a preference to trade long positions in tech stocks. Again, the study was during a period where the Nasdaq more than doubled - so the result that only ~1/3rd of day traders made any profit at all makes that result seem quite a bit worse.
The study concludes:
The day trading industry, and numerous books and advertisements about day trading, actively promote the idea that day trading is an easy route to wealth and early retirement. This idea has led to widespread interest in day trading and the entry of many novice day traders. The fact that at least 64% of the day traders in this study lost money suggests that it is more difficult to be a profitable day trader than the industry maintains.
Retail FX Day Trading: Comments on SEC Release No. 34–64874by published by ,
In 2011 the SEC was seeking industry comment on whether/if/how they should further impose regulation of firms and processes that allow retail investors to day trade FX securities. The comments received by the SEC can be found here. Included in the comments was the linked report above by Philadelphia Financial Management of San Francisco, compiled from the available disclosures made by retail FX trading firms.
The report is especially damning of the retail FX trading firms of the era, which were flagrantly taking advantage of their customers - but much of the data and lessons is applicable to day traders in other markets. Some of the highlights are below. Note that this refers to retail FX traders from around 2008-2011.
- Around 70% of retail FX day traders lost money each quarter. This number was highly consistent across the 12 FX brokers studied.
- The average retail FX day trader had an account balance of less than $5,000, and traded twice per day.
- These day trader accounts were often funded via credit cards (e.g., 81% of new accounts at FXCM, 41% of new accounts at Gain Capital).
- Day trading clients of Gain Capital saw quarterly results ranging from negative 34% (worst quarter) to negative 27% (best quarter) in 2009-10. Comparatively, clients of Charles Schwab (not a day trading firm) saw performance of negative 7% to positive 9% in the same period.
- Retail FX trading costs were very substantially higher than that of buy-and-hold investors at other firms.
- When executing trades, some retail FX firms inform the market maker of the client's level of sophistication, which then directly affects the quote received. I.e. ("this person will be too dumb to know you're giving them an awful price on this trade.")
- Quoting from the report: "In the retail FX market, different investors are given different quotes and institutional investors receive far superior quotes than retail. For example the revenue per value executed at Gain Capital is 10x higher for retail clients than for institutional clients."