The Long Term in Day Trading may be a very long time indeed.
There are lots of people who claim to have made a profit from day trading. Some of these people, unfortunately, may be outright liars. Some of them don’t keep proper accounts and might genuinely believe they’ve made a profit, even when they haven’t. Some of them, however, have indeed made a profit over the limited time that they’ve been trading, but that does not necessarily mean they are making a long-term profit.
Many people — from business owners and poker players to people who gamble on horse races — have ended up losing money because short-term gains led them to mistakenly believe they were making a long-term profit. Many day traders, unfortunately, come unstuck for very similar reasons.
Making a short-term profit from day trading is no great achievement. If you buy a bunch of shares at random and sell them again later on in the same day, you may very well have made a profit. That does not mean, of course, that you will be able to do the same thing the next day or the day after that.
It’s OK to have a bad day sometimes, of course, so long as you are heading for a decent long-term profit. The trouble is that many people are very keen to believe they are making a long-term profit when, in fact, they are not.
A person who makes a profit from day trading in a single day may just have got lucky. If someone came to you and said they’re a successful day trader and it turned out they’d only been trading for one day, you would probably be somewhat less than impressed. What counts is whether they have a positive expectation of profit over the long term.
(For those people not at all familiar with Mathematics, a ‘positive expectation’ means you may or may not make a profit, but if you could live your life a thousand times over, you will make a profit, on average. That’s no guarantee, however, that you will make a profit in this particular life.)
But over what period do you have to be making a profit, before you can reasonably conclude that it is a long-term profit and not just a short-term blip?
Obviously, a profit over a few days or over a few weeks is not enough to signify a long-term profit. It just isn’t enough time for luck to even itself out. Even people who gamble on horse racing can make profits over such short periods. In the long-run, however, the odds are all on the side of the bookmaker.
But what happens if you’ve been day trading (in shares) every day for 5 years — and, although you haven’t made a profit in every one of those days, you have made a significant profit overall? Surely that means you’re making a long-term profit, doesn’t it?
No. I’m afraid it doesn’t. You see, five years is not the long-term in the stock market.
Historically, share prices have tended to follow a sort of pattern. The pattern is that, whilst they have short-term ups and downs each day and each week, they tend to follow a longer-term trend of gradually increasing over a number of years…
…until there’s a stock market crash. There could, for example, be a sudden crash on a single day that could wipe out the increases that have occurred over a number of years. It’s happened many times before and it’ll be a miracle if it doesn’t happen again.
Of course, it would be great if you could trade profitably for years and then get out before the crash. The trouble then comes in trying to accurately predict when that crash will happen.
You might trade for five years and get out just before a big crash happens. You’ve made a profit, but unless you knew when the crash was going to occur, it isn’t really a true long-term profit. You just got lucky.
You could easily have been unlucky. You could have just started day trading and that occasional major crash — be it Black Monday, Black Tuesday, Black Wednesday, Black Thursday or Panic Friday — occurred on your very first day. And it could take years to recover those losses.
Your expected long-term profit is what you would have got on average — taking into account the chances that you will be hit by one of these major crashes. So, if someone claims to be making a long-term profit from day trading, ask them this: Did you trade throughout an entire economic cycle?
The stock market tends, in broad terms, to follow (or perhaps lead) the economic cycle. It tends to grow during the boom years, but often has a major crash just before a major recession. So, to assess a day trader’s long-term profits, it would be sensible to look at how they’ve performed over an entire economic cycle — through both the boom and the bust.
Making a profit over the boom years alone does not mean you’re making a long-term profit — unless, of course, you have a reliable way of knowing when a big crash is likely to come along and you can turn your assets into gold before that happens.