When we talk about the rise in day trading over the course of the Covid-19 crisis, there are really three key dynamics in play. The first is that, for better or for worse, people’s financial situations have been thrust into the spotlight. The second is that, throughout lockdown, boredom led people to hobbies they’d never previously considered.
Finally, and perhaps most importantly, people love a get rich quick scheme. This is a fundamental dynamic in this story, one that will ultimately bring day trading back down to earth once the hysteria subsides. The likelihood of making it big on day trading is questionable – for every big winner there will also be losers.
What is day trading?
Let’s explain exactly what we mean by day trading. Put simply, it is the practice of trading (buying and selling) financial instruments within the same trading day (or after a short period of time). Rather than focusing on broad, diversified, long-term growth, day trading is about sniffing out quick wins and, often, being first to stocks that take off.
You might remember the GameStop saga that took place in February of this year. Led by a community on Reddit, investors pushed the price of the video game company’s stock up by 30 times in a matter of days. There were two peaks in the space of a week, with plenty of people making (and losing) a lot of money buying and selling GameStop stock – and even derivatives – over the period.
Most instances of day trading are far less dramatic. Investors will target individual stocks, monitor their performance, sometimes making money when they sell and sometimes losing it. It’s not a long-term strategy and is, in our view, more akin to gambling than it is serious wealth management.
Investing is difficult to get right
So, let’s explain why day trading rarely works out for the investor. Investing is difficult to get right – our entire business is built around the notion that people would rather entrust their savings to a team of qualified, experienced professionals than risk losing out by flying solo. Everyone kicks themselves when they hear about a stock soaring to unprecedented heights and they imagine the money they could’ve made with a little more faith.
The problem comes when people buy a stock after its peak. It is notoriously difficult to predict how entire markets will behave with any certainty, and it’s particularly difficult to predict what an individual stock will do. Just as many investors rode the GameStop hype to the peak and sold, many then bought for a slice of the pie and were left wanting.
However, despite this, millions of people took up personal trading during the pandemic. According to City AM, 1.8 million UK adults took up day trading over the course of the last 18 months or so. More than a fifth of adults traded shares in some form or other over the same period, as millions of people found themselves on furlough or similarly confined to their own homes.
“I don’t confuse day traders with serious investors,” said Princeton professor Burton Malkiel, author of A Random Walk Down Wall Street. “Serious investing involves broad diversification, rebalancing, active tax management, avoiding market timing, staying the course, and the use of investment instruments such as ETFs, with rock bottom fees. Don’t be misled with false claims of easy profits from day trading.”
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A study published in 2019 from the University of Sao Paulo found that, despite what day trading courses may tell you, “97% of all individuals who persisted [with day trading] for more than 300 days lost money. Only 1.1% earned more than the Brazilian minimum wage and only 0.5% earned more than the initial salary of a bank teller — all with great risk.” Their conclusion was that it is “virtually impossible for individuals to day trade for a living.”
Robinhood’s rollercoaster reputation
Perhaps no service optimises the attitude towards day trading than Robinhood. The US broker has been one of the drivers in bringing trading to the masses, pulling it out of suited-and-booted financial trading centres and putting it right into people’s hands.
The company was founded in 2013 and has been building since, though it was thrust into the limelight during lockdown. Those with plenty of time on their hands turned to day trading as a way to use their newfound disposable cash and chase the kind of headline-grabbing market wins that seem to underpin the aspirations every would-be investor.
The firm made headlines in February during the GameStop saga, when the so-called meme-stock was being traded so frantically that Robinhood was forced to suspend trading. The owners were quick to dismiss rumours that the decision was made with any Wall Street interests in mind, but the episode had at least an anecdotal impact on the business’ reputation.
After the GameStop saga – and some celebrity condemnations from the likes of Elon Musk – this reputational damage clearly spread to Robinhood’s users. According to a survey from Fortune, “56% of Robinhood account holders [were] considering leaving the platform as a result of the fiasco.” The company was also the only one of an extensive list of financial services providers to have a negative favourability score in a separate Fortune survey of investors.
It is predicted that the return to normality taking place in countries across the world will have a dulling effect on day trading. As people start to spend more, enjoy time outside of the home, travel, and everything else that comes with the end of lockdown, the appeal of buying and selling stocks on a daily basis is likely to wane.
Achieving long-term financial goals
In our opinion, day trading is not a sound long term financial strategy. If you have the financial security to absorb losses, trading could be an enjoyable distraction, but there is a large body of academic evidence to suggest that day traders struggle to make money over any significant period of time.
We believe that a fully diversified, actively managed investment portfolio is the way to go. Moneyfarm’s portfolios are built around each individual investor’s attitude to (and capacity to absorb) risk. We’ll match you with a portfolio that’s built to preserve and grow wealth over the long term, so that you can get on with the things that really matter.
Where day trading usually means buying single assets, we build our portfolios using high quality ETFs – essentially groups of stocks or bonds – to create investments that are diversified across geographies, asset classes and currencies. The idea is to protect our investors from the kind of aggressive fluctuations in value that day traders rely on (and suffer from). If you’re interested in a more long term investment approach, see how a Moneyfarm portfolio could work for you.