Day trading, active trading, swing trading, position trading, forex trading, option trading or general market timing generally is a losing proposition for most people. However, there have been some that have managed to amass large amounts of money doing it. The success stories and magnitude of the returns is enticing, but one must consider many factors when deciding if they want to pursue this career.
The Emotional Tax
For most people I imagine that winning money does not equally offset losing money. For instance. Imagine you went to a casino and won $50 on the first game, but then on the second you lost $50 then you left and went home. For the outside this would look like a net neutral event, but for the individual I bet they would leave feeling bad they “lost” the $50 that they had won earlier.
You can even flip the event. If one started in the hole losing $50 on the first bet and then then winning $50 to break even they still may feel as they lost since they didn’t make anything from the risk and time they took.
See only if you win, win often, and win big do you emotionally feel satisfied. I think successful traders are able to handle these emotions differently than most. I have heard they don’t get the same rush that most of us get from seeing the green and red profit loss entries pop up in the trading account. This is one area that sets them apart. For most though this emotional strife is going to seep into our everyday life, family life, and possibly our day jobs. Losing money can make you feel bad about many things outside of trading. It seems on the surface this is enough to say trading is not worth it.
Time Value Opportunity Cost of Trading
We have to remember that any time spent trading could have been spent on leisure or working to earn money. So if you spent 40 hours a week trading and broke even you effectively lost money, because of the hours that could have been used to earn a wage.
This gets even more complicated when you factor in historical stock and bond investments. Over time a 60/40 stock bond fund has returned over 8% per year in the long run. Of course the past does not predict the future. Yet this still should be considered. If you can earn 8% by buying index funds and essentially doing nothing, then you have time freed up to work and earn money to invest to earn this return.
In essence you must cover the market drift that can be achieved without any active trade management. Why would one trade if they can’t beat passive investment returns?
Therefore, if you made 12% active trading you really need to compare it to the market return. This can vary widely year to year, but you can use an average across a few years to determine if you are being compensated fairly for your time. If the market made 10% then take your 12% and subtract the market return of 10% and you will have effectively earned a 2% additional gain for your efforts.
Account Size and Return v. Wages
For most people with smaller savings or investment accounts that 2% difference is very unlikely to make up for the amount of time you spent trading to achieve it. If you could have worked another job for wages you would have done better. However, if you have a big account then that 2% very well could be far more valuable than any wages.
You have to evaluate several things: your earning potential in the job market, account size, and excess return over the stock market. We can use a simple equation to quantify this.
- Let A= Investment Account size
- Let T = Trading Return
- Let I = Passive investment returns (benchmark)
- Let H = Hours spent trading
- Equation: [A(T-I)] / H
For example. Someone that has a $100,000 account size, spends 20 hours a week trading, has a yearly return of 15% while the benchmark portfolio returned 6% over the same period.
Since the return is in terms of years we need to multiply the 20 hours per week by 52 to give us 1,040 hours spent for the year.
Plugging in the variables we get: [100,000(.15-.06)] / 1,040 = $8.65 per hour
As long as you are honest about the total hours spent you can find out at what wage you would have to earn working to earn more than trading. In the example above it would seem most would earn more putting more hours in at the job. But if one could earn a higher return, had a larger account balance, or could do it with less hours this would shift considerably.
An example of a boost to all 3: 1,000,000(.2-.06) / 500 = $280 an hour
Clearly trading can be well worth it for some, but certainly not for all.
Trading Can Be A Hobby
In the above example I would venture to guess that for most people trading simply is not worth it. Likely the excess return above the stock and bond market cannot be achieved with consistently at a high enough rate to make a significant difference. However, similar to selecting a career, sometimes people will take a lower paying job if they get more satisfaction out of it. If trading is something you enjoy much more than alternative careers, then even if the equation finds the total amount of money comes out less than working that is okay so long as you can meet expenses.
Can You Make A Living From Trading?
For most people I do not think this is a likely possibility. The dream of having no boss to answer to, working from home, flexible time off, and no earning ceiling makes this desirable for a lot of people. However, what we don’t always consider is that most professionals manage trades for outside money. They don’t have to get 100% yearly returns to make millions of dollars. The secret is as long as they can earn a few percentage points above the benchmark they can get many interested investors. These investors invest millions into the funds and agree to being charged a percentage point or two depending on the fund and its track record. This is the way I see it being realistic for a trader to make money. However, it is not the same as the original dream. Now you have investors and the fund management team to answer to when you have an investment idea or trade not pan out. Now that only adds even more pressure to a stressful endeavor to being with.
How can you be sure you will continue to beat the market?
For those that still desire to be an independent successful trader how can you be sure you will continue to be profitable? The only thing I can think of is that you devote only a portion of your overall resources to trading. The problem with going all in, is that even if you don’t go to zero you more than likely will stop and discontinue once the drawdown hits a certain pain level. This would be catastrophic as going in that 60/40 portfolio would have likely preserved and increased your savings.
Using only a portion of your resources will make living off of trading much harder as you have to earn a large excess return to make up for the lower amount of working capitol. However, I see this as the only prudent way to go down this path. If you went all in and it worked out that would be a great feeling, but if you lost it all when you could have made consistent money passively that would be gut wrenching.
Trying to live off of trading is an extremely difficult task unless you have a very large bank account. If you have enough in savings there also comes a point where there is no need to earn anything beyond the market return anyways.
For most that aspire to trade to earn a living I think the only way forward is to start small, part time, and work your way up slowly. Be careful not to neglect your family, self, or your day job to pursue trading.