The hidden costs of DIY investing – Part 2 – Day trading
It is very tempting to manage one’s own investments and many dive head first into it. There are two aspects that drive people to try this: being in control and save money. Although most of the people that claim that the latter is the reason, the fact is they want to be in control. Because of that there are zillions of companies and individuals advertising and teaching the “hidden secrets of trading (or investing) success”. However, one aspect that not a single one touches is the costs of trading for a living. So, let’s get to it and do some number crushing. In the first article we discussed the long term investor. In this second article we will move to the other end of the spectrum and evaluate the day trader. In the third article, we will crunch the numbers for the very popular swing trader. The last article will wrap it all with some considerations and suggestions.
Day trading
It amazes me how day trading seems attractive to the newbie. Maybe it is because they do not know it better. Or maybe it is all the “trader lifestyle” advertising. It seems attractive to be day trading from a beach in paradise or a cruise ship in the middle of the ocean – seriously, you can buy day trading courses that include a cruise! Anyway, it does not matter if one’s goal is to “fire the boss” or move to paradise, the marketing around it makes it really attractive. It is a very lucrative industry for several segments, from book sellers to discount brokers. Not so much for the wannabe day traders….
The general approach is to sell a training course and suggest “a great discount broker” that caters to day traders. The trainer can be getting a break on his own cost (if he is addicted to day trading) or a share of the trading commissions. Anyway you put it; it is lucrative for everyone but the aspiring day trader.
Very few will make it and become truly lucrative in the long run. Day trading is very demanding in terms of discipline and emotional strength. There are numerous stories of damaged fortunes and families. If you are a newbie considering day trading, please don’t.
A special niche of the day trading industry is Proprietary Trading. If you want to insist on trying day trading and will do it anyway, I suggest that you give Prop Trading a shot. At least you can find some reputable company to join. It is neither cheap nor easy, though. The common arrangement is that the aspiring trader has to pay for a course to learn about the market the company focus on, the platform the company uses and the strategies their traders follow. After the course the student will need to use a demo platform for some time. Think of it as a flight simulator. Here again there are the good and the bad, but both training and simulation are important steps. However, keep in mind this is not cheap. These courses can cost over $10,000.00. But for many aspiring day traders I have met this is a lot cheaper than if you try do learn by yourself!
If the aspiring trader completes the training successfully and is approved most of the companies will require a deposit. This money will be used to cover the losses incurred by the brand new trader. Yes, a Prop Trader uses company money and shares the profits with the company but pay for the losses. When the deposit drops to zero, our aspiring trader is out of a job. The smart ones use this as a wakeup call and give up day trading. However, many will believe in excuses and continue trading. I met a few like that and it was very saddening.
If you make it and become a Prop Trader you will join a select group that work very hard but makes a good living. Some will quit the firm and trade their own money; usually to be able to reduce the number of working days and have more free time.
However, the costs are not low and one needs to have a large trading account, even though typically a good day trader will do just a couple of trades a day. Some days they will not trade at all because the market is not behaving they whey they need. A good day trader only follows a couple of companies, but pay close attention to the market as a whole. What appears on the news can affect their results and a day trader needs to have (and pay) for a good news feed.
So, what are the costs involved with day trading? For our simulation I will use a low trading cost of $2.99 per trade. I will not consider the news feed cost or platform cost because these can vary tremendously and are included with some platforms. Keep in mind that these numbers are in US$, since the Canadian market is not the market of choice for most of the day traders.
For our simulation I will consider that our trader only follows two companies and does an average of two round trip (one buy and sell is a round trip) trades per day. I will consider that our trader only works four days per week because day trading is really demanding and one needs extra rest. I will consider also that our trader only trades the morning session or four hours per day. I will also consider two hours for preparation and operation management (studying the market and operations management). This number of hours is in the low side. I have seen people investing more than four hours on studying the market alone.
The first table considers that our aspiring trader has $50,000.00 available for trading.
Trading cost ($) | Hours per week working | Hourly wage ($/h) | Labour + trading cost ($/Year) | Amount invested ($) | Profits to cover cost (%/year) |
$2,392.00 | 24 | 25.00 | 33,592.00 | 50,000.00 | 67.18% |
$2,392.00 | 24 | 40.00 | 52,312.00 | 50,000.00 | 104.62% |
$2,392.00 | 24 | 70.00 | 89,752.00 | 50,000.00 | 179.50% |
$2,392.00 | 24 | 100.00 | 127,192.00 | 50,000.00 | 254.38% |
Notice that the profits required to cover the costs are very high, even for a good day trader that can double their money every few months. The risk of blowing out the trading account is very high and a professional knows it will happen. Remember, money is the raw material for the day trader; with no money, there is no trade.
How much would be reasonable to fund a day trader? Well, a lot more than $50,000.00. There are as many different opinions as there are stars in the sky, but my personal suggestion is $1,500,000.00. For this size of account the operational costs are more reasonable and there is room for some bad days.
Trading cost ($) | Hours per week working | Hourly wage ($/h) | Labour + trading cost ($/Year) | Amount invested ($) | Profits to cover cost (%/year) |
$2,392.00 | 24 | 25.00 | 33,592.00 | 1,500,000.00 | 2.24% |
$2,392.00 | 24 | 40.00 | 52,312.00 | 1,500,000.00 | 3.49% |
$2,392.00 | 24 | 70.00 | 89,752.00 | 1,500,000.00 | 5.98% |
$2,392.00 | 24 | 100.00 | 127,192.00 | 1,500,000.00 | 8.48% |
But, would a person with this amount of money invest in day trading? Well, that is a very personal decision, but at 6%/year $1,500,000.00 can generate $90,000.00 of passive income. That’s far enough to live the “trader life” in a paradisiac beach…
In the third article of this series we are going to discuss the very popular swing trading approach, that (supposedly) is easier. Stay tuned!
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