Why Day Trading Needs to be Boring

The benefits are easy to see. There’ll be no boss looking over your shoulder; you can work from home or anywhere else, there’ll be flexible working hours. And as if that isn’t reason enough, there could be unlimited earnings potential as well.

However, while a day trading career allows a great deal of freedom, this can just become a longer rope with which to hang yourself.

Given the challenges and the high dropout rate, anyone thinking of doing this for a living is wise to go in with their eyes open. That is easier said than done. When we hear of easy money to be made we often want to ignore everything else – especially the negatives.

Dismiss any ideas of triple digits returns

If you have to turn a profit just to get by, the pressure to succeed as a day trader will be overwhelming. The danger is that this obsession will grow into a debilitating distraction. Not just to your work life but to your personal life as well.

To be in it for the long haul trading needs to be uneventful. Just like a real job. So get back to reality and throw away any ideas of triple digits returns. Forget about turning that $5000 into your retirement nest egg within six months. It isn’t going to happen.

Your rate of return will be proportional to your starting funds. A target of single to low double digit annual returns is realistic to begin with. That means you would need to have at least $250,000 just to make an annual profit of about $25,000.

Of course most people have much less capital than this. But lower capital means fees will be a higher proportion of profits. And this can lure the trader with low cash reserves into much riskier bets than they’d otherwise take.

A day at the office shouldn’t feel like a white-knuckle ride

Does it feel like a white-knuckle ride whenever you put on a trade? If the answer is yes, something is going wrong. This kind of excitement may be great for the recreational trader. But for the career trader it can be devastating.

High emotions mean too much is vested in the outcome of a particular position turning a profit. In other words this is when trading is spinning out of control and becoming gambling.

Just as companies don’t want their profit and share price to be dictated by things outside of their control, so it should be for the day trader.

Don’t let the movement of the S&P 500 or oil futures dictate if you can sleep or not.

When too much capital is risked on one particular position, the outcome of that event has too much emotional significance. The exposure to any individual market should be limited through proper risk controls and money management.

Not spreading the risk across different asset types is the same as taking positions that are too big. If all bets are on the same horse it doesn’t matter how many individual bets are placed because they all depend on the same outcome.

Don’t plan your future on uncertain trading profits

Let’s face it, if banks and other financial organizations had to rely on the whims of the markets for profits, most would have gone bust years ago. This is why their client services like brokerage, asset management, advisory and market making are necessary for their survival.

It’s true that proprietary trading desks can make a lot of money in years when markets are easy, the good years. However they can also make thumping great losses in bad years.

If proprietary trading grows too big in proportion to the balance sheet of the firm, trouble is not far away.

This same rule applies to the private trader as well. Nobody, no matter how big, can rely on uncertain trading profits for their income.

Financial markets are non-deterministic most of the time. Whatever technicals or fundamentals might be saying, whatever rule system you have in place, there will always be uncertainty. The only thing that is predictable about financial markets is that they are unpredictable.

This means that for the average day trader, the pendulum can swing abruptly between profits and losses.

For this reason, the sensible day trader always secures a base income that’s enough to survive on. This might be support from a spouse, passive investment income or wages from a second job.

Experienced traders usually supplement their trading profits with more reliable cash flows such as those from selling covered options, securities lending, stock dividends, and through fixed income securities. This helps to even out irregularities.

What about the professional trader?

When looking at the role of the private trader it’s natural to draw comparison with professional traders who work in the financial services sector. While this is helpful to a point there are some important differences.

Firstly when talking about employed proprietary traders, these individuals aren’t trading their own money but their firm’s money. Secondly, they aren’t lone rangers. In all but the smallest trading operations, they work in teams, called trading desks, where risk is shared, and so is responsibility.

They have the advantage of being able to focus all effort on a selected market. The bonuses are usually tied to the performance of the trading desk and the organization as much as to the individual.

Given this eco system they work in, there is less of an emotional attachment than a private trader would to have to his or her personal account. And this is a good thing and entirely necessary. It helps them remain detached.

The support team around them is made up of supervisors, analysts, product controllers, risk controllers, compliance officers, and so on. It’s a strong system designed to prevent run away losses. In other words the structure is pretty tightly controlled compared to the private trader sitting in his basement with a laptop.

The private trader has the sole responsibility for this entire set of job functions. He or she needs to have a hat for each of these; risk, technicals, fundamentals, supervisory right the way down to end of year tax reporting. If just one part of the system fails, the whole enterprise can fail.

Reduce unknowns as far as possible

There’s a common saying that businesses hate uncertainty. The activities of the day trader should be no different. Any trading operation should be run with tight controls, with no surprises, and by eliminating unknowns as far as possible.

As in any job there will always be dull, procedural things that have to be done that we’d all rather just sweep under the rug.

These tasks include organization, administration, planning, review and training. While this isn’t especially exciting, it is just as vital to success as reading the markets. Sidestepping these functions removes some of the safety nets.

Is there a level playing field?

The mainstay of financial markets is that they are not controlled by any one group or individual. This idea of a level playing field is one thing that draws people to the possibility of day trading for a living in the first place.

Nevertheless many pundits will say the odds are stacked against the private trader because the professionals know the rules, control the markets, and are there to suck profits from anyone stupid enough to go inside.

But it has to be said that many day traders are their own worst enemies.  When things do go wrong often the reasons are much closer to home than they realize.