Photo by Anna Nekrashevich
Day trading and active trading are often portrayed as quick paths to riches, but the reality is far different. Most day traders end up losing money over time, and the odds of consistently outperforming the market are extremely low, tk reported.
Active trading involves the buying and selling of securities with the aim of capitalizing on short-term price fluctuations. It typically entails holding positions for brief periods, although the specific duration can vary widely, according to Investopedia. Day traders who execute numerous trades daily engage in highly active trading, whereas swing traders who open or close positions every few days may also fall under the category of active traders for many observers.
Day traders differ from active traders, who trade frequently but not always within the same day. Active traders focus on short-term opportunities but may hold a position for multiple days. All day traders are active traders, but not all active traders are day traders, according to TD Bank.
Actively investing and trading, as opposed to opting for passive investment options like SPY ETF or Berkshire Hathaway, can be viewed as a challenging pursuit. The low probability of consistently beating the S&P 500 index, coupled with the time-intensive nature of active trading, raises questions about its long-term viability. While some traders may achieve short-term success, academic research suggests that, over time, most individuals struggle to outperform the market.
Here are five reason to buy and hold for the long term.
Studies consistently show that the majority of day traders fail to make a profit over the long term. Princeton professor Burton Malkiel, author of “A Random Walk Down Wall Street,” emphasizes that successful investing involves diversification, rebalancing, and avoiding market timing. Day trading tends to lack these fundamental principles.
“I don’t confuse day traders with serious investors,” Malkiel wrote in a blog for Wealthfront, where he is chief investment officer. “Serious investing involves broad diversification, rebalancing, active tax management, avoiding market timing, staying the course, and the use of investment instruments such as ETFs, with rock bottom fees. Don’t be misled with false claims of easy profits from day trading.”
A recent study on Robinhood traders found that during extreme herding events, the stocks bought by Robinhood users experienced return reversals, leading to losses. Herd behavior and the ease of access to trading platforms can result in erratic market movements, making it challenging for day traders to predict price movements accurately.
Many Robinhood users are inexperienced, often chasing the performance of popular stocks. This inexperience can lead to impulsive trading decisions and losses. Additionally, the platform’s design emphasizes active trading, encouraging users to buy stocks aggressively.
Stocks that quickly rise due to Robinhood traders’ buying often experience sharp declines. Short sellers are keenly aware of these patterns, contributing to the reversals. This makes it difficult for day traders to profit consistently.
The study “Attention Induced Trading and Returns: Evidence from Robinhood Users,” published in October, examined trading activity of Robinhood from May 2, 2018, to Aug. 13, 2020. It studied “extreme herding events,” where Robinhood traders crowded into particular stocks. The study found that during these extreme “herding events,” “the top 0.5% of stocks bought by Robinhood each day experience return reversals on average of approximately 5% over the next month whereas the more extreme herding events have reversals of approximately 9%.”
“Large increases in Robinhood users are often accompanied by large price spikes and are followed by reliably negative returns,” stated the study.
According to the authors, most Robinhood investors are inexperienced, so they tend to chase performance, CNBC reported.
Active trading incurs higher transaction costs and tax implications. Traders who buy and hold stocks for the long term benefit from lower capital gains tax rates. Constantly buying and selling can erode potential gains through fees and taxes, according to TurboTax.
Photo by Anna Nekrashevich: https://www.pexels.com/photo/person-holding-a-smartphone-6801874/
