Understanding the Risks of Day Trading

When you’re creating a long-term financial plan, including retirement planning, investing in the stock market is very often a big part of that. The stock market is one of the best ways to see significant returns on your money.

Historically, these returns tend to be higher than you’ll get with many other investments.

However, most people who are investing in the stock market as part of a retirement plan do so with a buy-and-hold strategy. That means you invest in solid stocks—usually ETFs or mutual funds—and you hold them for the long-term.

You’re a passive investor, and some financial experts will even advise you to avoid checking your accounts during downtimes, so you’re not tempted to make an emotional decision.

What about day trading, however? That’s when you’re an active investor. Day trading is something that was once only available to people working for big financial institutions and brokerages. Now, with online trading, essentially, it’s open to everyone, but does that mean you should participate?

With day trading, you’re buying and selling based on short-term moves in the market. For example, you might trade based on current events or short-term expectations.

The following are some risks to be aware of before you dabble in day trading.

It’s Difficult to Do Well Without In-Depth Knowledge

You may think by watching a few hours of financial news every day, you’re ready to day trade. The reality is that active day traders who do well at it typically have very in-depth knowledge on a highly technical level.

An effective day trader will know how to read charts and do technical analysis. Even with those skills, however, charts may not tell you what you really need to know.

You’re Competing Against the Professionals

You have to keep in mind that anytime you’re engaging in day trading, you are actively competing against the professionals.

They have connections for information, data subscriptions, and the most cutting-edge technology.

Even with all of these tools and resources, still professionals fail.

If you’re dabbling in day trading and you don’t know much about it, you’re actually someone a professional loves because they’re poised to make money off you.

Emotions Can Cloud Your Judgment

If you’re day trading as a non-professional, it’s very likely that your emotions can impact the choices you make.

For example,  if you have a winning stock, there’s a high chance you’ll sell it too early or, on the flip side, keep a bad stock too long.

There’s also a fear element when it comes to selling something or buying something, and if you aren’t a professional, it’s tough to overcome that fear. Plus, you probably have a lot less capital to work with than a professional, so you’re going to feel those inevitable losses a lot more.

Day traders frequently use leveraged investment strategies, meaning they use borrowed capital to buy stocks and securities. That might mean margin or options trading. Then, with leveraged investing, you may increase your profits if things go in the right direction, but it’s risky.

The Risks of Leveraged Investment Strategies

If you’re using a leveraged investment strategy and something goes in the wrong direction, you can lose money very quickly. In fact, there’s the possibility of losing more than your initial investment. Sometimes you can lose a great deal more.

Good Day Traders Have a Tried-and-True Strategy

If you go into day trading without a tested strategy that you can rely on, you’re likely already at a disadvantage.

What will happen, though, is that you might read someone else’s strategy and think you can replicate it. Then you might even have a few successes, leading you to take bigger and bigger risks, and ultimately that’s probably going to cause problems.

Day traders who do well at it don’t just come up with a strategy. They test many different strategies over time. Often, they do it first through demo trading, so they aren’t using real money.

Then, they can see the effects of that strategy and understand how the demo would have fared in the real-world market.

Finally, somewhat like the emotional components, you have to think about your psychological and personality traits that could be problematic for you in day trading. For example, how do you react under stress or uncertainty? Are you too willing to take risks or not willing enough? Do you even have the attention span to trade for hours at a time?

These are all things to think about when weighing the risks of day trading.