2023 EP1007 | Financial Updates | Risks & Rewards of Day Trading

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Welcome to Planning Matters Radio. Peter, I am really excited about today's topic, day trading, the risks and the rewards fueled by COVID lockdowns and the rise of commission-free brokerages like Robinhood. Online trading or day trading, as it's known, has seen a huge rise in popularity over the last few years.

Here's a look at some new E-Trade accounts that started during COVID. The Internet, of course, is still full of influencers now peddling their particular courses or video series promising to unlock the secret windfall to profits. However, according to several recent financial studies, Peter, almost all day traders lose lots of money, particularly after accounting for fees and taxes. So I want to ask, you know, self-directed investing offers potential cost savings and many learning opportunities. What are the advantages of self-directed investing? Yeah, well, learning opportunities is great because you want to be knowledgeable and comfortable with what's going on with your money. But that education can be rather expensive. Advantages are that it is accessible today.

It is low cost, no cost. And you mentioned Robinhood in particular. That's a platform that I think grew in popularity because of its ability to purchase fractional shares and its access to crypto. But crypto in particular, a lot of people were getting into that with not much education ahead of time.

And man, did they have a costly education in many cases. I mean, you wouldn't go into Vegas with your life savings the first time that you went gambling. And you would hope to know something about the games.

But if you didn't, you would expect that whatever you took in there, you may lose it as you are learning how to play the game. And that's a little bit of I think what's going on with day trading. Yes, it's accessible, which is fantastic that we as individuals can go and have a stake in the market. I sell trade stocks, funds, ETFs, what have you, even even that crypto, if you so choose.

But don't do it with all your money, folks, because it can be very costly. The market can move very quickly. And you mentioned the influencers, Aaron. I think that this is really akin to the gold rush where the ones that made the money were the ones that were selling the dungarees and the picks and shovels. The miners themselves oftentimes didn't really make all that much money. And I think that those influencers behind the scenes, a lot of times they are not only kind of giving the education that, hey, you you do have access to this, but also selling some kind of service, some A.I. or or algorithm that they have developed or have access to that tells you exactly when to execute your trades and what to buy or maybe some newsletter that that does it. And behind the scenes, I think that they are the ones making the money.

Even if they aren't offering that, it's the views that they get that that is their stream of revenue. Oftentimes, if they were absolutely perfect with their algorithm or A.I., they they would just be trading themselves. They wouldn't be telling them.

You're right. They wouldn't be sharing their secrets. So I was surprised that these studies found that only one to three percent of day traders consistently earn above market returns. Why is that?

Why is that number so low? Well, we have talked about the Dow Bar study, and I think we'll touch probably a little bit more on that. But we react with emotion.

I mean, it's attractive. It's alluring the get rich quick and easy possibilities that are out there purportedly. But in reality, when we see things go just a hair wrong, we also panic and have greed and and fear. And those two emotions guide a lot of the investment decisions. And what happens is that we do the wrong thing at the wrong time, almost inevitably, when our emotions mix with our money. And so when somebody who may not have the discipline or experience goes in and opens this online trading account or day trading account, a lot of times those emotions take over and that's what leads to mistakes and underperformance there.

And there's a lot of research that backs up the fact that without a plan, without a discipline and without the help of an advisor, somebody that sort of holds you accountable to the plan and some guidelines that individual investors underperform those that use those or have that plan in place. Right. Right. So let's drill down into some specifics. So let's say that we do want to begin online trading, maybe not with our life savings. Like you said, let's walk through how it would happen. First, you suggest you need to consider your approach and your expectations. Right.

Yeah. Again, don't go in with your life savings. If you want to experiment and have some fun money or some wild money kind of account, then that is that is perfectly fine.

There are lots of people with lots of expensive hobbies that they don't mind putting money into now for trading. I would say set your limit, put in how much you would be comfortable in a given month or a given period of time. Start with that and say, well, if I learn and lose this all, I am OK. But I also have the mainstay of my true financial progress toward my retirement plan in in some other kind of more traditional retirement investing approach and also set upper and lower limits.

Right. If the account gets to I do have success and it grows to a certain amount. That's when I'm going to take some profits off the table because I am not comfortable losing this much money. Whereas what I start with, I would be OK with that. So your approach and expectations need to be defined from the beginning.

And you also need to know how how much how often you are going to be paying attention to this, logging in and executing those trades. Is it kind of a once a month kind of a thing? Or are you doing this minute by minute, day by day? This is now your full time job.

And I have seen people where it has started one way and then become almost a full time job, distracting them from other things in life. Of course, because it's like you're back in Vegas, like the first analogy you began with. Also, so hard to take money off the table, Peter, when you're winning. It is. It is.

They didn't build those casinos off of the winners that walked home with their winnings, though. And the same is true in the online trading world. Yes.

All right. So the second thing to consider here, your risk tolerance. What are we keeping in mind? We are keeping in mind that in the grand scheme of things, the expectation should be that we are keeping things in alignment in our total picture. So if we are shooting or aiming to beat the market, that is a highly aggressive stance.

I would qualify it as almost speculative. In reality, most people don't have that kind of risk tolerance. Most of my clients and the people that I talk to are actually well further back on the risk tolerance scale, both self-described.

And when we go through our risk tolerance questionnaire, we may find that they are moderate or moderately conservative or even conservative. Well, even for that individual, it may be OK to take advantage of the access to inexpensive trading in the market. But you've got to look at the total allocation, the total percentages of your wealth that you have in these various approaches. Are we taking 100 percent of risk with 100 percent of our money?

You shouldn't. And if you are conservative or moderate, understand that you probably are not going to be comfortable being positioned to capture 100 percent of the gains of the market, because if you capture 100 percent of the gains of the market on the upside, you also capture 100 percent of the losses on the downside. So there's sort of a sliding scale and it's not exact, but that that chart kind of gave an indication. If you are conservative or moderate or aggressive, there's a certain percentage of the movement of the market that you should be expecting and willing and accepting of capturing both on the upside and the downside.

Now, if you are utilizing the services of a professional adviser, hopefully part of their job for you is to capture a little bit more toward the upper end of that range when there are good times, when the market's moving up and a little closer to the downside of that range when the market's moving down or there are some challenging times. So now let's move through the third consideration. Consider the risks. And there are two specific risks that I want to chat about. The first one, we touched on it before, and it is behavioral finance.

Yeah. When when things are going well, we all get greedy and can do no wrong. I'm smarter than the market.

I figured it out until we haven't. And that happens very quickly. And then when things are going poorly, when when we see those losses, I mean, it can cause depression when we see mistakes that we've made with our money and we can wallow in it and beat ourselves up. But it certainly also does cause people to make kind of the wrong moves and transactions at the wrong time. Oh, well, I took that first investment and I doubled it.

So now I need to put everything I have into it. No, let's let's back up from that. Let's keep a measured pace and make sure that we continue to along the way only take risks that we are comfortable taking. And then when everybody is panicking about the market falling, which does happen periodically, you know, that's the time when everybody sort of backs out and goes to cash. When oftentimes those more successful long term traders with a long term outlook and time horizon understand and identify that as an opportunity to move in when prices are cheap.

So we we just tend to do the wrong things at the wrong time. Again, Aaron, when emotions and money are mixed and that Dow Bar Research Institute study, they they study investor behavior and results for about 35 years consecutively have shown that individual investors simply make the wrong decisions at the wrong time and therefore end up underperforming by a very wide margin. And the second risk that we want to touch on that I think a lot of day traders don't consider. We heard about this a lot during covid taxes, huge tax implications to day trading.

Yeah, there can be. And again, it's easy to open these accounts today. Again, we picked on one kind of online upstart the Robin Hood, but you could do it at E-Trade or Schwab or Fidelity or Vanguard.

Not a recommendation of any of those. Simply a list of a few of them where you can go and quickly with just the click of a few buttons, open an account. But if you are opening a trading account, the type of account matters. So are we doing this with a non qualified account, which is usually the first one that pops up when you go to open one is just an individual brokerage or trading account. Or are we doing this with qualified money, meaning IRA or Roth money, and therefore we have limits in the amount that we can put in in a given year.

But there are also some distinct advantages. If you have an IRA or a Roth, all of those trades and transactions happen under the shelter, under the umbrella of tax deferral or tax free growth. Those the transactions are not taxable events.

Whereas if you open a non qualified account, again, what people people typically do more often than not. Well, all of those trades, each individual transaction is a taxable event potentially. And when you are day trading or trading, even if it's just on a on a semi regular basis, oftentimes there's a lot of transactions going on. So you might make a good amount of money.

But within each one of those transactions, if you are realizing gains, that is a taxable event. And unfortunately, by the end of the year, maybe you've lost money or broken even. And then you've got this tax documentation and reconciliation that you have to do to figure out, well, what did I net net and how did each trade impact?

It can be really costly. I've seen people absolutely surprised by that tax bill that shows up at the end of the year on their online brokerage trading account. And so you really got to understand the type of account, what it's going to do. Now, there is the possibility of doing what's called tax loss harvesting, which means that if you've got some winners and you've got some losers, if you sell both of them, they can sort of cancel each other out. And if you've got a non qualified account, you've got to understand not only what you're buying, what you're investing in, how you're transacting it, but what the tax implications are going to be as well. So much to consider.

And we talked about this a second ago offline, Peter. To me, it's overwhelming. I wouldn't want to spend my time self directing my own money.

Yeah. So there there is a value to being confident and understanding what is going on with your money. And I do think that you can gain some of that that confidence and knowledge by seeing how the market works, by actually being involved in the trading. But a lot of times people just don't have the time to dedicate to it. The market moves very quickly.

They don't have the desire to to do it, or they may not have the knowledge and understanding to make well informed, well thought through decisions. So I think there is credence to both sides. Again, just if you are going to do it, segment how much you are willing to do it with and kind of hold that off to the side and then understand that if you are taking a more traditional approach on the other side, kind of that long term retirement investment kind of approach versus day trading, the results on the two sides may be very different over any given period of time.

It's hard to benchmark. Great topic. Yeah. This was very, very helpful. If somebody has questions about opening account or how much they should put on the table, what's the best way to reach you?

Yeah. Give us a call. And I've got many clients that have those fund money accounts over on the other side. So whether you just want to bounce some ideas off of an investment professional and investment advisor representative, or you would like to actually be involved in a relationship, I'm happy to look over what you're doing, talk over any questions with you.

Give us call nine one nine three zero zero five eight eight six nine one nine three zero zero five eight eight six. You can also visit online rich on planning dot com is what it looks like. It's my last name, Peter Roshan Roshan planning dot com.

You can email me Peter at Roshan planning dot com. Peter, thank you so much for your time today. Really like this topic. Absolutely. I appreciate it there.

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