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Why Day Trading?

“Because it’s there!” What has come to be known as day trading is new, and many are lured by it. Of course, day trading is as old as the first market, but it has generally been the preserve of professionals. Now one finds traders of all degrees of experience at innumerable trading houses hunched over computers, buying and selling in seconds or minutes, hundreds of trades a day. Uncountable trading rooms in cyberspace connect thousands of traders all over the world, responding instantly to “calls” made by head traders to buy or sell. And in countless chatrooms, this or that stock is touted or rumored into buying or selling frenzies by traders acting on this information alone.

Four factors converging in the last few years of the twentieth century have made this possible:

  1. The computer
  2. The Internet
  3. Discount brokerage fees
  4. and an unprecedented Bull Market

These, combined with the ever-present lust for quick fortune, have produced a new market dynamic:

A massive degree of public participation in short-term trading.

Volatility in some markets is obviously a direct result of day trading activity. Whether this amounts to more than day traders buying and selling to one another is not yet clear. What is clear is that trading is not investing. If trading is “take the money and run,” investing is “plant the money and let it grow.” Trading is always short term in its orientation, whether for 6 seconds, 6 hours, or 6 days. Investment is always intended to be long term.

Trading aspires to the growth of capital; investment to growth in ownership. The wealth of a trader is measured in units of currency; that of an investor in units of equity. The trader always seeks cash in pocket; the investor certificates of ownership (shares). Investment is long term because it generally takes a long time to accumulate a sizable degree of ownership. Unless an investment goes sour (e.g., a company fails), there is often no incentive to divest — even when there are large “profits” in the value of an investor’s position. The trader, however, seeks something quite different. The trader seeks gains now. The trader in effect attempts to reduce the time element to near zero. While a 15 percent return in a year’s time would be considered satisfying to the investor, the trader wants this in a day!

Day Trading Example

Consider the capital multiplying potential that the “new” day trading makes possible. The following chart illustrates the price action in a volatile stock over the course of a day’s trading.

In this example, the closing price is the same as the open price, so the nightly news will report that XYZ was “unchanged.” As is clear, however, the price of XYZ was full of changes during the day. Imagine there exists a method that would work as follows.

The trader buys on the open at 23, sells at that first peak at 25 (+2), buys again at 23, sells at the peak at 27 (+4), buys again at 25, sells at 29 (+4), buys again at 21, and closes out at 23 (+2). Adding up these gains, the trader would have a total gain of 12 points in four trades. That’s more than a 50 percent return in one day!

Imagine further that, in addition to buying at the lows of each move, the trader sold short at the peaks. In this case, the trader’s total gain would be more than 100 percent in one day! Thus, if it were possible to capitalize fully on the rise and fall of a stock’s price during the day, a large percentage return of one’s capital could be achieved in short order. In fact, there is no other mechanism of wealth-generating potential as potent as the multiplying effect of capital market price movements.

Perfect capture of price movement as illustrated in the above example, of course, is impossible. But impossible or not, it is some portion of that daily price potential that the day trader seeks to capture. And even if the trader captures only 10 percent of that total price movement on a daily basis, the annual income of that trader would be astronomical by most anyone’s standards. That is the lure of day trading.

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