Why You Should Not Day Trade | White Coat Investor

I never thought I would have to write this post, but clearly its time has come. This blog has only ever run one post about day trading, but I didn’t write it; it was a guest post back in 2017. However, over the last 6-24 months, day trading seems to be making a comeback among retail investors.

I suspect part of it is fueled by the huge stock market gains of 2019. Part of it likely comes from a volatile stock market in 2020 and lots of people sitting at home with extra time due to the COVID pandemic worried about their incomes. Perhaps the prominence, name recognition and outperformance of the large, well-known growth stocks (FAANG, Tesla Zoom etc) is drawing people in. Maybe it’s also due to the fact that many casinos were forced to close for the pandemic.

Some of the newer brokerages aiming to make trading fun, exciting, and accessible (I’m looking at you Robinhood, Thinkorswim, and Webull) are not helping the cause either. Robinhood alone opened 3 million new accounts in the first quarter of 2020. That’s 1% of Americans. I’m even getting calls from friends who have never had any interest whatsoever in investing asking me about how they can trade stocks and what I think of Robinhood. I’m sure you can imagine my answer. They have an upcoming IPO, so soon you can buy Robinhood at Robinhood!

Physician financial blogs come and go. Over the years there have been at least 100. Some of the latest ones are no longer doling out sensible financial advice, but are instead advocating picking stocks and day trading. They read like a cocktail party conversation, only talking about their winners, sharing carefully crafted screenshots demonstrating success, inspiring Fear of Missing Out (FOMO) while using carefully crafted disclaimers to try to absolve themselves of moral responsibility for the acts of their readers (“Statistically speaking, you will more than likely lose money doing this, and could lose all of your working capital.”) Even the WCI Facebook Group has people advocating for not only individual stock investing, but day trading those stocks.

My favorite part of that particular question is that the asker thinks that owning stocks for a few months is “buying and holding”.

The last time day trading was really popular was before many of my readers were adults. In fact, it occurred before I ever started earning money. Back in the 1990s, day trading was cool, just like it is now. People were quitting their jobs to day trade. Doctors swapped stocks between patients. I even had a med school classmate or two who were checking portfolios and placing trades in the student lounge between classes. That all seemed to go away after the tech crash.

You see, many traders mistake a bull market for skill. They tend to trade the stocks with the best recent returns, which tend to fall the hardest. So for a while, they trade and trade and trade, making money the whole time, not realizing it is due to the tailwind at their backs. Since a good trader “should not require a tailwind”, they continue to trade when the tailwind becomes a headwind, and then find out their technique is not as profitable as they thought. As Warren Buffett has said, “Only when the tide goes out do you discover who has been swimming naked.”

Eventually, most day traders either run out of money or develop enough humility to realize this was all a terrible idea. If you do not know a doctor who has lost their shirt day trading, you have not talked to enough doctors about their finances.

Eight Reasons Not To Day Trade

Let’s go over a few reasons why you should not day trade.

# 1 You Don’t Have To

Here is the first reason. It’s the same reason you don’t have to buy Bitcoin or manage rental apartments. You have a very easy, nearly automatic, practically guaranteed pathway to wealth. You already have a high income as a high-income professional like a physician, dentist, attorney, etc. My typical reader is either already making or soon will be making $200-600K per year.

Carving out 20% of that money and investing it into a boring old static asset allocation of stock and bond index funds over the course of your career, mostly inside of retirement funds, is likely to leave you a multi-millionaire with more money than you know what to do with. This is a method that is easy to understand, easy to implement, nearly guaranteed, and completely reproducible by essentially every doctor in the country.

In a hurry? Save 30-50% instead of just 20%. Putting away $150K a year and earning 8% on it gets you to $4 Million in just 15 years. $7 Million in 20 years. $11 Million in 25 years. 55 is still considered an early retirement the last time I checked. You can have a shortened career, spend six figures every year of that career, and still end up with an estate tax problem without ever making a single day trade. If there is anyone who does not need to day trade, it is my readers.

# 2 Most Traders Lose Money

Here’s an even bigger issue. Most traders lose money. The academic evidence of this is overwhelming. Let me cite a few examples:

Here’s one from Brazil:

Well, maybe it just doesn’t work in Brazil. Or doesn’t work with equity futures. How about this one from Taiwan?

80% lost money, before fees and taxes. It was even worse afterward. It’s interesting to dive into the data on this one. Here’s a table from the study:

Lots of numbers there, let’s just take a look at the lower part of the table, Panel B. The top line there is the best of the best. These 393 investors (0.77%) are either very talented or very lucky. They were profitable on 71% of their trading days. On average, they made $7,532 in Taiwan dollars each day (about $256 US dollars). Kudos to them. The next line down, 2% of the traders, were profitable on about 50% of trading days. They did not make as much as the first group, but they did make money, about $1,445 in Taiwan dollars (about $49 US dollars). The other 97% lost money. So in the words of Dirty Harry…

But wait, there’s more. Again from Taiwan, but a different (and longer) time period. Here’s the money shot from the paper:

As you can see, only a tiny percentage of traders are profitable. The conclusion is pretty damning:

Same authors, looking at US Data.

The more you trade, the worse you do. Their abstract says it well:

Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent. The average household earns an annual return of 16.4 percent, tilts its common stock investment toward high-beta, small, value stocks, and turns over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.

Still not convinced? Here is a two hour recorded presentation by a professional trader that likely will convince you. You really want to bet against this guy and his peers? Who do you think is on the other side of your little trades from your little computer in your little basement? Or those trades you’re making behind the curtain in the exam room with your iPhone between patients? Here’s one of his slides from the presentation, explaining all the marketing you’re seeing from Robinhood, etc:

The whole point of this website is to help you get a fair shake on Wall Street. The point is to take a look at the evidence about investing, see what is likely to work, and do that. The evidence is pretty darn clear about day trading. It does not work for the vast majority. Thinking you are in that tiny minority is more likely a reflection of overconfidence than it is a reasonable bet.

# 3 Few Traders Accurately Track True Returns

I am amazed at how few investors actually know how to track their returns. Of those who know how, even fewer actually do it in any sort of meaningful way. If you really want to know what you’re making, use the XIRR function in a spreadsheet. However, that’s just your gross return. If you really want to know your true return, there are a few things you may need to subtract from that return.

1. Expenses. While commissions, advisory fees, brokerage fees, and bid-ask spreads likely come out of that trading account of yours, you will need to separately account for any other expenses. Buying books on trading? Count them. A trading course? Count it. That new, faster computer? Count it. Those software programs? Count them.
2. Taxes. You know how you qualify for long term capital gains rates if you sell an investment you have owned for more than one year? Day traders don’t get those. If they should be so lucky as to have profits, they pay ordinary income tax rates on them, further reducing their return.
3. The Value of Your Time. Responses in the Facebook group suggest people are spending 2-3 hours a day with their trading activities. If a typical physician makes $200 an hour, that’s $500 a day in opportunity cost. If you trade 20 days a month, that’s a $10,000 per month hurdle you have to get over just to begin making money.
4. The Cost of the Stress. All the traders talk about how stressful it is to do this. There’s a cost to that. While it is difficult to quantify, ignoring it completely is not the correct answer either. Add a factor in for this.
5. Market Returns. Since market returns are basically free with a simple index fund, you may also want to subtract those from your profits since that portion of the return did not come from your efforts.

I’m confident that the vast majority of day trading doctors who think they are profitable will discover they are not if they would simply track their true returns.

# 4 It’s a Lousy Job

While most doctors tempted to do this will attempt to day trade using a few minutes at lunch or between patients, there are a few who will take it on as a job. They will spend their day doing research, watching the markets, and putting in trade orders. It becomes their job. They report to their computer each morning and sign off each day when the market closes.

Now, I want you to go back in your mind to high school or college and try to remember the dreams you had about your life and your career. How many of them involved you sitting in front of a computer screen watching numbers go up and down for years on end? Oh, none? Weird. You mean you had a dream to actually help other people and make a difference in the world? What happened? Yes, doctors spend entirely too much time in front of computer screens, but they don’t spend all their time there. I’m sure there are plenty of jobs worse than day trading, but it still sounds like a terrible job to me.

# 5 It Takes You Away From an Important Job

You have an important job. A job that matters. A job you are respected for. A job that makes a serious difference in the lives of your patients or clients. If you leave it to day trade, that job will not be done. If you are constantly thinking about your positions while the patient is in front of you, you’re going to do a terrible job. Imagine rushing through a surgery to get back to the lounge or your phone to check on that trade from this morning? Imagine explaining to your patient what you were really thinking about while their bowel or EKG was in your hand? Your work matters. Far more than the work of the vast majority of people in the financial services industry. Don’t throw that away due to your FOMO. Day trading adds zero benefit to the world. Zero. In fact, the benefit is probably a net negative. I thank doctors for what they do every time I record a podcast. I never thank day traders for what they do. And don’t give me that baloney about “making the market more liquid.” We already have ten times the trading going on that we need to keep markets liquid enough for the purposes of real investors.

# 6 It Encourages a Gambling Mentality

Gambling is addicting. There are Gambler’s Anonymous chapters all over the world. That dopamine rush brings people back to the tables, the lottery, and yes, the stock market, over and over again. Buying shares of a company because you want to share in its earnings over time is investing. Buying and holding index funds for decades is investing. Buying that house down the street and renting it out is investing. Buying a stock you only plan to hold for minutes or hours is pure speculation. It’s gambling. And it encourages a gambling mentality.

Even if you totally luck out and it turns out you are good at this, you will view it as a money-making machine you can return to at any time and you will cease to be a good steward of what you already have. Gambling might be harmless when you are betting quarters at your weekly poker game. But everybody knows someone whose life has been destroyed by gambling. As Warren Buffett said, “If you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes.”

Don’t believe me? Don’t think most day traders are gambling? Let’s look at the academic evidence. Again, from Taiwan.

Multiple natural experiments of large jackpot lotteries in Taiwan are used to document that some individual investors trade stocks as a form of gambling, whereby those investors substitute lottery gambling for stock trading. Our study accentuates the following findings. First, when the jackpot exceeds 500 million Taiwan dollars, the number of shares traded by individual investors decreases between 6% and 10% among stocks with high individual trading fraction, low market capitalization, high past returns, and high past turnover, and the effect is statistically significant. Second, the reduction in individual trading ranges between 5.4% and 7% among stocks with lottery features. Third, the magnitude of the decline increases monotonically with the jackpot size. Fourth, firm-level trading activity reacts negatively to large jackpots and is statistically significant for a sizable number of firms. Fifth, the aggregate trading activity by individual investors declines by about 5% on large jackpot days. Sixth, the substitution effect is preserved when the lottery sales and the size of the jackpot are employed as alternative instruments for gambling. Finally, the substitution effect is found to adversely affect the liquidity among certain types of stocks, while it fails to show up in the options market and in stock trading by institutional investors.

Don’t kid yourself that you are immune to this effect. Here’s another one from Alok Kumar:

This paper examines whether socio-economic and psychological factors which are known to influence lottery purchases lead to excess investment in lottery-type stocks. The results indicate that, unlike institutional investors, individual investors prefer stocks with lottery-type features. The demand for lottery-type stocks increases during bad economic times and such demand shifts influence the returns of lottery-type stocks. In the cross-section, factors which induce greater expenditure in lotteries also induce greater investment in lottery-type stocks – poor, young men who live in urban, Republican dominated regions and belong to specific minority (African-American and Hispanic) and religious (Catholic) groups invest more in lottery type stocks. Additionally, investors who exhibit stronger preference for lottery-type stocks experience greater mean under-performance. Collectively, the evidence indicates that people’s attitudes toward gambling are reflected in their stock investment choices and stock returns.

As George Goodman explained, “If you don’t know who you are, [the stock market] is an expensive place to find out.” If you are treating the stock market as a casino, it works just like a casino–the fewer trips you make through it, the better you do.

# 7 It Is Difficult to Distinguish Luck From Skill

Here is another dilemma I hope you face if you start day trading and accurately tabulate your returns. You might find out you are winning. Now you are left to decide whether you are actually skillful or whether you got lucky. While our natural tendency is to attribute all of our successes to our skill and to ascribe our failures to bad luck, the best course of action moving forward is highly dependent on whether it was luck or skill. Good luck with figuring that out. Just like with choosing actively managed mutual fund managers, by the time you have enough data to be reasonably sure that results are due to skill, the game is already over.

# 8 Techniques Stop Working

A bigger dilemma with day trading is that you may stumble onto a technique that works. The problem is there are millions of other people out there looking for techniques that work. So if you find a technique that works, for heaven’s sake don’t tell anyone about it. And don’t go out and teach a course about it. Once the word is out, the profits will be arbitraged away by all the other people doing it. Thus you should not expect any technique you learned in a trading course to continue to work. When this technique you found stops working, what are the odds that the next one you find is also a winner? Not very good.

So, dear reader, while it is not impossible to beat the market day trading, nor is it impossible to quit your job as a nephrologist and make more sitting in front of your computer putting in trades, the odds are not only against you, but overwhelmingly against you. If the match rate for your medical school were only 3%, nobody would spend four years of their life studying there, much less borrowing hundreds of thousands of dollars to do it. Yet those same doctors are willing to bet similar amounts of money on a <3% chance of successful day trading. Good luck.

What do you think? Do you think day trading is a smart thing to do? Do you think most of our nation’s doctors should leave medicine to day trade? Why or why not?