The Dangers Of Day Trading

Day trading is a type of trading in which the objective is to place many trades over the course of the day with the hope of  making lots of small profits over and over again. A significant portion of traders are attracted to this type of trading mainly due to the idea of them being able to make large profits very quickly. The majority of these traders do not understand the inherent risk or danger presented by day trading the forex markets, with this article I hope to raise some important points about why day trading is unlikely to result in a successful career for you whilst also explaining why the vast majority of day traders are unprofitable in their trading.

 

What Is Day Trading ?

 

Before I explain the many dangers of day trading I think it would be worthwhile if we talk about what day trading actually is as I know alot of people can get confused by the different interpretations online of what constitutes to day trading.

Day trading is a form of trading where the trader will place anywhere from 10 to 100 trades ( in some cases it could be more ) over the course of a single day. The holding time of these trades is incredibly small. Trades could be held anywhere from a few seconds to a few minutes, its highly unlikely they will be held for more than an hour.

The trading strategies used by day traders are very similar to the strategies used by other traders only they have been adapted for use on the extremely low time frames day traders primarily trade-off.

Typically the 1 minute chart will be used to identify setups and execute trading positions with the 5 minute chart being used for trend identification. Most of the common technical analysis teachings will be implemented by the day trader, watching swing highs and swing lows to determine trend, breakouts of support or resistance, indicators like moving averages, relative strength index, momentum, MACD are also used by day traders to enter and exit trades.

Really there isn’t much difference between day traders and other traders, yet its proven long-term trading is more profitable than day trading, why is this ?

 

I’m A Day Trader Too !

I’m a day trader too !

Only the type of day trading I participate in is quite different to the standard day trader definition laid out to you above.

There are two big differences between typical day traders and the day trading I partake in.

The first is the amount of trades I’ll place during the day.

When I trade, I’m not looking to place more than 3-4 trades a day, its rare for me to even place 4 trades in a single day.

Compare that with day traders who are placing upwards of 50 trades a day then its easy to see there are major differences between they way these day traders trade and the way I trade.

The second difference is the holding time of each one of the trades I place.

Since I primarily trade-off the 1 hour chart, the trading strategies I tend to use are all geared towards holding onto trades for as long as possible, I’m not looking to make a few pips on each trade, I want to make at least 50 pips on every trade I place.

Ideally my goal has, and always will be, to get a trade placed at the beginning of a long trend. I know the profit potential of having a trade placed onto a long trend far outweighs the profits that can be made by placing lots of small trades over the course of the day.

The ability to scale into bigger and bigger positions gives the opportunity to multiply profits far quicker than what is possible through day trading.

 

The Attraction Of Quick Rewards

 

I’ve asked myself many times what is it about day trading that makes it so popular ?

Really I think it comes down to an attraction of being able to make lots of money really quickly.

In today’s day and age people want things fast, they don’t want to wait to make money, they want to make it right now. In my last article “the reason you close trades too early” I talk about how traders cannot hold onto profitable trades for a significant length of time, one of the reason for this is the pain of holding attraction of quick rewards.

When people place a trade and proceed to close it a few minutes later making a profit in the process, they enjoy it more.

Holding onto trades for a long period of time is very difficult thing for the majority of traders to do, people find much easier to just open and close a trade within a short space of time, that way they do not have to go through the pain caused by having the market potentially reversing against their trades, ending up with them coming out with less profit than what was initially expected.

Another less likely reason I believe people are attracted to day trading is the lifestyle they assume it will bring.

When people see day traders in action whether it be in film or on videos what they tend to see is someone sat at a trading desk eyes glued to several computer monitors trading loads of different markets all at once.

When normal people see this they make the assumption that day trading is this high adrenaline high-octane activity, they feel like their going to sit around all day making loads of money and having a good time, their completely unprepared for the stress and frustration that comes with making and losing money over the course of a day, it would be fantastic if you could just sit around all day making money, day trading would be easy if that were the case !

Unfortunately the reality is quite different.

 

 

Are Day Traders Profitable ?

 

Day traders usually end up being far less profitable than long-term traders simply due to the costs associated with placing so many trades over the course of the day. As you know when you place a trade you must pay the spread, of course this differs from market to market, in forex the major currencies all tend to have very low spreads which is what makes them attractive for trading by day traders, the lower the spread the lower the amount of money they must pay per trade.

A trader who places 1 trade a day only has to pay the spread 5 times a week. A day trader, who may place 5 trades within the first 10 minutes of the market opening, might end up paying the spread 500 times a week, assuming they place 50 trades a day.

So by the end of the day, the day trader may have made more money than he’s lost but still be down on his account due to the commissions he has had to pay out to his broker. On top of this, due to the extremely low time-frames day traders trade-off it means the distance of their stop-loss from entry is smaller, therefore they have the ability to use higher leverage when their placing trades.

When the leverage increases so does the cost of the spread.

Example

EUR/USD 1 pip spread = £1.00 – If trading at the lowest leverage available.

EUR/USD 1 pip spread = £10.00 If trading at ten times the lowest leverage available.

So if the day trader is trading at a higher leverage not only does he stand to lose more money but he also must deal with the commissions he has to pay out to his trading broker being higher.

 

The Original Day Traders

 

Day traders have been around since the dawn of trading, over the last two decades the format in which day trading used to be  conducted has changed dramatically.

Pit traders who stand in the exchanges and trade are the original day traders. These were people who bought and sold different currencies, commodities and stocks very quickly over the course of the day.

The vast majority of pit traders were driven out of the market by high frequency trading algorithms which were able to front run the buy and sell orders placed into the market by the pit traders. These algorithms are able to place trades far faster than any human can, which means they can pick up on things the pit traders can’t, decreasing the edge pit traders used to have over other people not present inside the exchange.

Now pit traders had a very important advantage over traders who were not present inside the pit.

In the pit, banks and other large institutions would be represented by traders who trade on their behalf, in fact I think it even said the name of the company they were trading for on the jackets worn by the pit traders.

What this means is the other traders in the pit know who’s in control of alot of money and since all the transactions must be made between different parties within the pit it would be possible to make money by watching and understanding what the other traders are doing.

If you see a trader getting angry you’d know he’s either lost money or is currently losing money on his trade,

Rather than in today’s world where we don’t know who’s on the other side of our trades back in those day you would be buying and selling with the people in the room, that’s how transactions used to take place before computers became commonplace. The person you were buying or selling to may have even been your friend ! If he sells and you buy and the market goes up the reason he has lost could be due to you buying.

A large percentage of forex traders wish to have access to the order book so they can see who’s buying and at what price are they buying at, being present in the pit gave you access to the order-book because the other traders in the pit were the orders !

You were physically able to watch other traders go up and place their trades, you would know what amount they have brought and at what price their trade was placed. This meant all you had to do to make money was study what the other traders were doing, if a trader who works for HSBC goes up and begins buying you know there’s a high chance of the market moving up from its current price, if you place a buy trade soon after the bank trader you have a decent chance of making money, his trade is likely to push the market higher making you a profit in the process.

Day traders have a large mountain to climb if they wish to become profitable trading forex.

If the pressure and stress of making and losing money over the course of the day doesn’t get to them then the broker commissions will. Look at all the successful traders through history, the majority of them were not day traders, the ones who were only made money back when pit trading was at its peak, most of these traders cannot make money from day trading anymore, the switch from being in the pits with everyone around you shouting out the prices they want to buy or sell at to being sat at home on a computer with no additional information is too much of an environmental switch for these traders to handle.

The pit traders strategy depended on understanding what the other traders in the pit were doing, if you take that away from them they don’t have a strategy anymore.

If your interested in learning more about pit traders and how they were forced out of the market then the documentary below will give you a good insight into what the business used to be like.

Summary

Whilst day trading is seen by many as a great way to make large amounts of money trading, the reality is it’s just a marketing gimmick used by brokers to entice traders into signing up with them so they can make money from all the commissions generated by the day trader placing loads of trades each day, if you really want to succeed in trading you must learn how to trade the higher time-frames, not only can you make more money but you’ll also have the added benefit of less stress in your life.

1 comment

  1. Awesome website you have here but I was wanting to know if you knew of any discussion boards that cover the same topics discussed in this article? I’d really like to be a part of group where I can get feedback from other experienced people that share the same interest. If you have any suggestions, please let me know. Bless you!

Leave a Reply

Your email address will not be published. Required fields are marked *