The Dangers of Day Trading

Here’s what you need to know.

By Mike Kerins, CFA, FRM On Feb 9, 2021

The current surge in day trading is reminiscent of the rampant speculation we saw in the mid-to-late 1990s. History tends to repeat itself, and Generation Z, which did not experience the pain associated with the burst of the dot-com bubble in 2000, is now falling victim to this practice. According to Citadel Securities, retail trading activity accounted for nearly 25% of this summer’s market volume, an increase from 10% in 2019.

When the pandemic hit, traditional sources of entertainment were shut down. With more free time than perhaps ever before, many individuals began buying investments, capitalizing on low valuations during periods of high market volatility. 

The decisions to buy and sell are made based on investor instinct or attractive domain names rather than careful evaluation of company fundamentals. For this reason, day trading can be detrimental to your long-term financial plan. 

Here are ways to offset those risks while taking advantage of the current market environment: 

Use gamification for good. Stock-trading apps have likened investing to gambling. Similar to gambling apps, these platforms make investing thrilling and addicting. Healthy uses of gamification can positively incentivize people to save and pay down debt. However, frequently trading in and out of the markets overlooks long-term goals and exposes investors to high levels of volatility. The S&P 500’s average annual volatility is 15% while individual stocks on the New York Stock Exchange average 40% volatility annually, opening up undiversified investors to potential downside. 

Beware of the risks you aren’t compensated for. While day trading can be risky on its own, trading on margin, which involves borrowing funds from your broker to purchase additional shares, is even more dangerous. If losses are incurred on an investment, these losses will be amplified for trades executed on margin. 

Like most loans, for example, you will be required to pay interest on the margin until it is repaid. The longer you hold the interest-bearing investments, the more debt you accrue. 

When you sell the stocks you traded, the proceeds first go toward repaying your broker. If your account drops below a certain level, you may be required to liquidate your holdings to pay down your loan. 

Partner with a financial advisor. Traders with long-term outlooks only incur occasional trading expenses to rebalance their portfolios. However, executing hundreds of trades a day runs up costs, which can hinder portfolio performance. Financial advisors can help you manage your investments to meet your long-term goals. When selecting a financial advisor, determine whether they are fee-only or commission based. It’s important to understand their fees and how they are paid. Find someone who understands your goals and will work with you to create a financial plan. 

About the Author: Mike Kerins, CFA, FRM, is founder and CEO of Lambertville-based RobustWealth, a digital wealth management platform designed to support independent advisors and enterprises. 

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