Gary Karz, CFA
Host of InvestorHome
Principal, Proficient Investment Management, LLC In the late 1990's numerous day trading firms sprouted around the country and there was a great deal of discussion about the practice of day trading. There were a number of studies (see below) of day traders at specific firms that attempted to answer the question of whether day traders make money. However, for several reasons, there was no definitive answer to the question. An initial problem was defining the term "day trader" and determining exactly how many day traders there were and still are. Additionally most day traders do not publicly disclose their results. But we can piece together the various sources of information and come to some general conclusions. Day traders were described in the preliminary prospectus for All-Tech (filed in 1998) as those who engage in the buying and selling of securities many times during the course of a day based on short-term price volatility. Day traders may be active multiple asset classes, for instance many focus on forex trading, or commodities, but the term day trading is typically associated with trading in stocks. They typically close out open positions by the end of trading day in order to manage risk when the markets are closed. Positions are sometimes closed within minutes of the initial purchase or sale. Some estimates of the number of dedicated "day traders" (that operate at day trading firms) were in the 5,000 range. Others estimated that there may have been another 250,000 people that use some kind of software or dedicated systems to trade full time from home. These people should be differentiated from people that have online accounts and that might occasionally place one or more day trades. For more on the definition of day traders and related discussions see
There have been many studies that have concluded that most day traders lose money, but there have also been studies that documented successful trading by day traders. The data currently available seems to imply the following results.
- Saints or sinners? from CNNfn (9/1/99)
- 2 Brokerage Firms Well Known in Frenzied Day-Trading World in the NY Times (7/30/99)
Many investment industry veterans suggested that day trading is/was a fad and/or argue that it is based on faulty numbers. There have also been a number of studies and press articles that have concluded that the vast majority of day traders lose money. But there were also some legitimate studies suggesting that day traders do in fact make money buying and selling stocks intra-day. Supporters of day trading can refer to a study that was published in the March/April 1998 edition of the respected Journal of Financial Economics. In The Trading Profits of SOES Bandits, Jeffrey H. Harris and Paul H. Schultz studied several weeks worth of data from two day trading firms and did indeed find evidence that the traders made money at the expense of market makers. SOES bandits was the term used to describe individual investors who use Nasdaqís Small Order Execution System (SOES) for day trading. 1000 shares was the maximum size allowed in SOES at the time of the study but SOES trading rules changed after 1996, removing some of the day traders' advantages. Harris and Schultz studied data from two different firms and found that in aggregate, traders at both firms made money after commissions for the several weeks studied. Harris and Schultz discussed the fact that SOES bandits were able to trade profitably with market makers even though they had less information. They suggest that because bandits keep the profits and bear the losses from their trades they have greater incentives to trade than the employees of market-making firms. The Bandits typically closed positions by placing limit orders through Instinet or SelectNet (a system that allowed bids and offers to be sent electronically to all market makers in a stock). The principal advantage of SelectNet and Instinet to SOES bandits was that they allowed trades within the Bid/Ask Spread. Its important to note that theoretically, there is a simple reason why it is possible for market makers and traders to make money buying and selling stocks. In fact, many professionals (market makers and professional traders) consistently make money doing just that. See The Bid/Ask Spread and Market Makers for more on this topic. The authors found that "SOES bandits make money only if they can close out positions within the spread through SelectNet or Instinet. Bandits who both initiate and close positions through SOES usually lose money." Interestingly, they found that trading profits declined when the holding period exceeded one minute and twenty seconds. Bandits lost money in positions held for more than five minutes. This topic is also discussed in Saints or sinners? from CNNfn (9/1/99). According to the article "Finance professors are, in fact, divided about the viability of day trading" and Professor Schultz suggests it's a game best left to young people with good memories because the fast pace of trading. On the other hand there have been a number of studies and investigations with less encouraging results. The most frequently cited is a study by Ronald L. Johnson for the NASAA. Johnson concluded in An Analysis of Public Day Trading at a Retail Day Trading Firm - Report of the Day Trading Project Group Findings and Recommendations (8/9/99) that the majority of traders studied lost money and the vast majority of traders ran the risk of losing their entire stakes. In an administrative complaint filed against a now-defunct day-trading firm, Massachusetts securities regulators alleged that only one of the branch's 68 accounts made money. According to an article in the NYTimes (Day Trading's Underbelly (8/1/99)) day trading has exceptionally high "washout rates" and "regulators who have examined the books of day-trading firms say that more than 9 out of 10 traders wind up losing money. Because most of these people disappear quietly when their cash runs out, few who replace them in the trading rooms know about them or their failures." Gretchen Morgenson from the NY Times also discussed the topic with Harvey Houtkin in 2 Brokerage Firms Well Known in Frenzied Day-Trading World (7/30/99). Morgenson spotted the following statement on the All-Tech web site: "Electronic Day Trading attracts people dead-ended or unhappy in their current field of endeavor and people with a desire to make trading their life's work." According to "Master of a New Universe" from The Washington Post (5/16/99), Mr. Houtkin estimated that one in three people survive to become full-time day traders while one of All-Tech's regional managers estimated the figure to be more like one in ten. In "Day trading is a quick road to financial ruin" (5/5/99), Humberto Cruz of the Sun Sentinel cites Laura Walsh, a certified financial planner who said she prepared 40 tax returns the prior year for investors doing online trading, and not one made a profit. According to Walsh none of the traders had any idea about the concept of the spread. A study by Houston-based Momentum Securities Management Co. came to mixed conclusions. The study had not been released to the public (as far as I know) but was described in several articles including a comprehensive article in the LATimes by Walter Hamilton, one of the most knowledgeable reporters on the topic. See Study Finds Beginning Day Traders Lose Money. The study of 107 traders for several months at six of Momentum's Texas offices found that 6 of 10 newcomers and more than one-third of experienced traders lost money. After a three-to-five-month "learning curve," the study found that profitability of traders improved with 65% making money and 35% losing money. Regulators pointed out that the study covers only a narrow group of traders over a brief period and survivorship bias may be an issue with this study. Additionally it apparently was not compiled by an independent source. An article in the Wall Street Journal (Single-Stock Swappers Trade One Stock and One Stock Only (12/7/99)) about day traders Gary Ratner (who trades CMGI) and Jeff Easton (who trades Yahoo!) suggests that they routinely make more than $2,000 a day. According to the article, Mr. Friedfertig says that through Nov. 30, 67% of Broadway's 400 active traders -- those who trade at least 3,000 shares a day -- were profitable for the year, and 78% of those who've traded for more than a year made money. In The Profitability of Day Traders (Nov/Dec 2003) in the Financial Analysts Journal, Douglas J. Jordan and J. David Diltz found that about twice as many day traders lose money as make money. Approximately 20 percent of sample day traders were more than marginally profitable. See also Fear and Greed in Financial Markets: A Clinical Study of Day-Traders from Andrew Lo, Dmitry V. Repin, and Brett Steenbarger (12/27/2004). We also have some international evidence thanks to Brad M. Barber, Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean. In there paper Do Individual Day Traders Make Money? Evidence from Taiwan they found that day trading by individual investors is prevalent in Taiwan Ė accounting for over 20 percent of total volume from 1995 through 1999 (individual investors account for over 97 percent of all day trading activity). They found that heavy day traders earn gross profits, but their profits are not sufficient to cover transaction costs and that in the typical six month period, more than eight out of ten day traders lose money. Yet they still found evidence of persistent ability for a relatively small group of day traders to cover transaction costs. See also Just How Much Do Individual Investors Lose by Trading? in the Review of Financial Studies (2009). The Wall Street Journal had an article about success rates of foreign-exchange traders titled The Customer Is Too Often Wrong at FXCM (3/26/2012). According to the article, which sources the company, "In each of the last four quarters , more than 70% of FXCM's U.S. accounts were unprofitable for those trading them." Another interesting question that follows along the same lines is whether it is possible to train individuals to become successful traders. The question was asked several times by Jack Schwager in his interviews with successful traders in the best seller Market Wizards. While hardly scientific, the following observations from the book are certainly interesting.
- The majority of new day traders probably do lose money.
- At some firms a very high percentage of day traders lose money.
- However, there is some evidence that a majority of (surviving) day traders at some firms are profitable and many traders generate tremendous returns on their money.
- Industry commentators also suggested in the past that day-traders using software at home are much less successful than those trading at professional day trading firms.
However, others interviewed in the book were apparently less successful in training others and less optimistic about probabilities of success.
- Richard Dennis described an experiment where 40 of 1000 applicants where chosen and 23 were eventually trained. According to Dennis "Itís frightening how well it worked." 3 dropped out, but the successful 20 (known by many as the "turtles") averaged 100% profits per year.
The percentage of profitable day traders is certainly an important number, especially for those considering day-trading as a potential career opportunity, but another relevant question is whether day traders in aggregate make or lose money. After all, in many industries a small percentage of the players make the majority of the profits. For example, let's hypothetically say that only 10% of day traders make money. Just that information certainly isn't encouraging. But what if we now assume that the average loss for each of the 90% that lose money is $100,000, while the 10% of profitable traders go on to earn an average of $2 million. We could then say that the expected return for all day traders in aggregate is greater than 100%. If 9 lose $100,000, but the one in ten successful traders earns millions, we now have a different picture. In fact, based on those numbers day trading is a better proposition than the lottery or casino gambling, where the house always holds the advantage by any measure. So clearly in analyzing the success of day-traders, we must analyze not only the percentage of day traders that make and lose money, but also the amounts that they win and lose individually and in aggregate. Regardless, it should be obvious to everyone that day trading as a career is only for people in the financial position to sustain the probably losses. Another important issue for potential day traders to consider is their opportunity costs. For instance, lets say day trader Loren has $125,000 in capital, currently makes $100,000 a year, and quits a job to start day trading. Loren . Loren expects to use $25,000 for living expenses for the next six months and the remaining $100,000 for risk capital. At the end of six moths Loren has lost half the capital and is left with $50,000. How much is Loren out from making the decision to day trade? The answer is not $50,000. Loren has day trading losses of $50,000 but thatís not all. Loren also gave up $50,000 in income from the job left behind, which brings us to a $100,000 pre-tax difference. And the final cost is the opportunity cost of not investing the $125,000, since that money could have been invested in stocks or bonds. So in reality a decision to day trade can cost you a lot more than the capital you lose trading. The time and opportunity costs should also be considered in evaluating the profitability of day trading for any individual.
- Bruce Kovner discussed trying to train perhaps thirty people, and only four or five turned out to be good traders. The other 25 left the business and according to Dennis "it had nothing to do with intelligence."
- Marty Schwartz discussed hiring four people but nobody lasted.
- According to Brian Gelber five or less out of every 100 people who go to the floor to become traders make at least a million dollars within five years and at least half will end up losing everything they came in with.
- Tom Baldwin responded that less than 20 percent of those who come to trade on the floor are still around after five years and one percent are successful to the point of making and keeping at least a couple of millionFor the typical retail investor, day trading isn't investing, it's gambling. If you want to gamble, go to Las Vegas; the food is better.
Philip A. Feigin in "Day Trading Craze Should Give Investors Pause" from NASAA (11/25/98)
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