How is it possible to lose or make money day trading?

Question

I read through similar questions here, but feel they did not solve my confusion. I've been considering the prospects of day trading with my money verses investing. My confusion is

If we neglect broker fees, I'm assuming day trading (not investing) is zero sum. If someone were to trade randomly (without experience), it appears they'd win half the time and lose half the time. However day trading winners win at loser's expense and there is a small population of absurdly profitable day trading winners (some examples are given in Market Wizards by Schwager). These two ideas seem in direct contradiction.

I'll elaborate some. Although investing is not zero-sum as the market's value grows over a long period of time, buying and selling quickly is zero sum as the stock is only held a short time.

The Intelligent Investor by Graham and some people advises that although investing is great, day trading is a losing game for most. Graham attributes these losses to broker fees, market impact, and taxes. But even without them, could day trading still be a losing game for most? Particularly given the random nature of the market and the supposedly random betting of most people.

Edit: I don't quite understand the negative votes and perhaps you could help me. I tried my best to define the question well by highlighting it and tried providing where the question came from. The following seemed legitimate to me:

In a zero sum world where inexperienced traders bet randomly, how could the elite traders possibly take money from amateurs?

Answer 1

Most day trading is based on some sort of technical analysis. You're looking for particular patterns in stock prices that provide a signal to buy or sell. The problem is that there are lots of very well capitalized firms that run very highly optimized algorithms to do high frequency trading based on technical analysis. These firms are getting the data with extremely low latency (i.e. they're spending lots of cash to get data microseconds earlier), they're able to process it faster than the human day trader, they're spending lots of money developing and testing their algorithms, and they're trading without human emotion so they're not tempted to do something stupid like making a big bet in the hopes of breaking even if they've had a run of bad luck. When you have a competition between a multi-billion dollar Wall Street firm and some guy in his basement, Wall Street is going to win well over half the time.

Then when you factor in the costs of day trading (financial, time, and stress), it is rare that someone comes out ahead. And it's extremely rare that someone comes out ahead consistently rather than simply being lucky. If you have 1024 traders each of which will win on 50% of the days and lose on 50% of the days, and you let them trade for 2 weeks (M-F), you'd expect that 1 of them would win 10 straight days. That particular trader will likely interpret that as an indication that he's really good at day trading when the reality is that he was simply the lucky one.

Answer 2

Even if day trading is a perfectly zero-sum game - by which I mean than every stock you buy has an equal chance of increasing or decreasing in price, and there are no trading costs - you're still facing the "gambler's ruin" problem: https://en.wikipedia.org/wiki/Gambler%27s_ruin That is, you have a finite amount of money to invest, while the rest of the market has an infinite (in reality, just very large) amount. Eventually you will experience a string of losses that wipes out your capital.

Answer 3

One Yes, it can be a losing game depending on human nature right? If you double down on losers too often or if you are too greedy and you lose your gains.

Two You can lose money by investing in individual stocks which perform badly.If you were just day trading a sector which is in decline, you would lose money over time as it declined (small loses each day of trading).

Three It is also hard to predict what will happen with a company on a day to day basis especially because macro factors affect stocks more than the companies themselves on a day to day basis.

I suppose if you actually randomly traded stocks and held all of factors constant then maybe you could get to zero sum. The loses come when you change things up in order to try and make profit.

Answer 4

Lets imagine that you pick them at random, and sell them x minutes later also at random. Note that x could be single digit minutes or hundreds of minutes later, and you do dozens of transactions each day. Each pair of transactions might make or lose money. If everything is truly random, then over the long term you would match the motions of the overall market. If the market for the year was up, you would also be up. If the market was down then you would also trend down.

Of course somebody would also be able to get the same result by investing in a broad index fund. That index fund would have low expenses, and is often tax efficient by minimizing capital gains.

The day trader expended time and money chasing the average. Of course if your method of picking wasn't random, but was a flawed method then you could be tricked into bad choices.

Once you factor in the cost of each transaction, then your random method would fall behind the general market. That is the equivalent of what the house takes at the casino.

Answer 5

I believe you're overthinking this. Imagine for a moment that stock movements are completely random and there are no fees. Then you can expect that day traders will achieve a fairly standard bell curve, with the peak at 0. Many people will break even, many will gain or lose just a little, and a few will gain or lose a lot.

Now if you add fees you simply shift the entire curve slightly to the left, making the average a slight loss rather than 0.

Many people believe that there is an element of skill in day trading, and if so, this would help determine where on the curve you land (the more skillful you are, the better your chances of landing further to the right), but the overall curve doesn't really change.

Answer 6

AFAIC, the stock market is zero sum.

For every buyer, there is a seller and the amount of money involved remains the same. Money just changes hands, regardless of what happens to the price of the stock. Here's a simple scenario:

There are 3 people (A, B, and C). Each one has $100 and A owns the stock. That’s $300 in existence. Let’s assume no slippage or transactional costs.

B buys the stock from A for $60. Now B has the stock. A has $160, B has $40 and the stock, and C has $100. That’s still $300 in existence.

If B now sells the stock to C for $80 then A has $160, B has $120, and C has $20 and the stock. the stock appreciated $20 and yet there's still only $300 in existence.

Now suppose the company goes bankrupt and the stock is delisted. A still has $160, B still has $120, and C still has $20 but no stock. Again, no money vanished and $300 still exists.

When share price rises significantly, paper wealth is created (not money). When share price drops significantly, paper wealth is wiped out (not money).

It's not an easy concept to swallow but when you buy a stock, your money is lost (someone else now has it). If share price appreciates and you sell, you get your money back and then some. That's where the tree analogy in your link fails. The author wrote:

If I sell that tree to a sawmill, they can cut the tree into usable lumber, and sell that lumber at a profit. They added their efforts and increased the value. A carpenter can increase the value even further by making something useful (a door, for example). A retail store can make that door more useful by transporting it to a location with a buyer, and a builder can make it even more useful by installing it on a house.

No one lost any money in any of these transactions. They bought something valuable, and made it more valuable by adding their effort.

The last person in the sequence lost his money when he paid for the final product (the house) and it is gone until someone else gives up his money for the house. If the house burns down and the home owner has no insurance, it's a total loss. In this tree to house example, the money supply also remained constant.