There are multiple ways in which someone can make money, outside of working a regular full-time job. One such income-generating plan is speculative investing. A speculative investment has a large risk of losing value but, at the same time, has the expectation of large gains. The draw of speculation for some people is that the risk of loss is psychologically minimized because of the possibility of a substantial gain. This means we have the tendency to downplay the risk while focusing on the reward.
Day trading sounds enticing for people who are driven to see the results of their investments fast. However, the risks of day trading are not something that can be ignored if you wish to avoid losing money.
Before making the decision to day-trade, it is important to educate yourself on what it entails, and why this trading strategy can bring major losses. With the help of a financial advisor, the underlying dangers of the stock market and day trades are much easier to understand and avoid.
What Is Day Trading?
Day trading is a trading strategy that entails purchasing and selling stocks on the same day in an effort to profit from sudden price fluctuations. Fast-paced, highly speculative, and requiring constant market and news monitoring, this degree of investing comes with many risks.
Day traders rely significantly on changes in the stock market to make money. Whatever the reason—a strong or weak earnings report, negative or positive information, or simply the mood of the market—they like equities that move a lot on a daily basis. They also choose highly liquid stocks, which enable them to enter and exit positions without significantly changing the stock’s price.
Investing With Borrowed Money
Buying on margin is the term for the method by which many traders are borrowing money for trading in order to increase earnings.
With a margin account, you can borrow up to 50% of the overall value of the investment you intend to purchase by using the securities you already hold as leverage. This kind of leverage can increase earnings exceeding what you could get with your own money, but it carries danger because your losses can also be multiplied.
Are There Benefits To Day Trading?
A successful day trader will definitely argue that day trading is worth a try if you apply the right day trading strategy. However, the number of investors who actually profit from day trading is small.
A Brazilian study that followed 20,000 investors over a 5-year period showed that only 17 out of 20,000 traders earned more than minimum wage after fees. Another study, which sought to find the differentiation between successful and unsuccessful traders in the Taiwan market followed 450,000 traders over a 14-year period. The study found that only 4,000 out of 450,000 were able to consistently profit after fees.
So why are so many people attracted to day trading – many like the excitement and the gambling psychology that comes with feeling good at occasional “easy” gains. Just like hitting a win at slots or some other casino game even though over time the gains will not last.
Day trading is avoided by many seasoned fund managers and financial consultants. They contend that the gain typically does not outweigh the risk. Furthermore, numerous economists and financial experts believe that active trading techniques of all kinds frequently fail to outperform a simpler passive index strategy over the long run, particularly if fees and taxes are factored in.
While employing the expertise of a financial advisor might increase your success rate, a good financial advisor would most likely advise you against becoming a day trader in the first place.
Risks Of Day Trading
The risks of day trading are numerous, and they can lead to losing money rapidly, no matter the day trading strategies you may choose to employ.
- Losing Money
This is a risk that all investors face. However, the nature of day trading and its volatility makes this a much more frequent occurrence, especially when buying on margin.
It is possible to lose hundreds, thousands, or even more during a single day of trading, based on the trading strategy used. Additionally, it is possible to lose all the money that was invested, along with any money that was borrowed and must be paid back with considerable interest.
- Higher Tax Impact
The potential tax repercussions are another risk of day trading.
The majority of the time, in the United States, you pay tax on short-term earnings from assets that you own for one year or under at your standard rate of income taxes. Gains from assets kept for over one year are considered long-term and are normally taxable at a reduced rate. The larger tax burden is something to take into account since most day traders have greater short-term gains than long-term.
- Greater Time Investment
Day trading necessitates spending hours at a computer monitoring the values of several securities. Additionally, it requires investigation into various techniques, education, exercise, and continuous improvement, none of which have a certain result. Some day traders may find that what begins as a hobby eventually turns into full-time employment.
- High Stress Levels
Every day trade comes with the possibility of making a few hundred dollars or losing multiple thousands. When trading stocks this rapidly, you have to be alert for all small price movements, act fast, and always brace yourself for possible great loss.
The stock market is a stressful place in and of itself, but day trading activities take the cake in terms of the toll they can take on your mental and physical well-being.
- High Expenses
Trading frequently can be costly. Traders frequently pay a variety of commissions and charges, even though the overall cost will vary depending on elements including the kinds of trades and the broker, institution, or trading system utilized.
Additionally, a trader’s expenses for learning, software, equipment, and research can quickly add up; all of these should be taken into account when estimating any expected returns, which adds to the risks of day trading.
Find The Best Investment Strategy For You
Given the high risks of day trading and the necessary time investment, it proves to not be the best investing strategy for most people. Nonetheless, Ridgewood Investments is committed to helping you figure out the best way to establish and grow your own alternative income stream.
Contact us and let’s start building a solid foundation for your financial freedom starting today!