Day-trading is hard, and most people lose money at it.

I definitely have. In fact, I once lost more money in a single day than many people earn in an entire year at a regular job. More on that in a bit.

First though, we have to figure out what the problem is and then we can look for ways to solve it. I will say though, that if you can follow two very simple rules, then it is very likely that you have what it takes to become a full-time trader.

There is a “well-known” statistic that 95% of all day traders lose money. That apocryphal number is probably low; it is likely closer to 98%. Although there have not been many rigorous academic studies to back up the statistics, there have been a few that shed light on the success or failure of active day-trading.

The Problem

Consider the following:

1. 66% of day traders quit day trading within a year of starting.¹ Why? Perhaps they were not successful and quit to avoid further losses or maybe they ran out of money and were unable to continue.
2. 76% drop out by two years, while only 15% survive for three years.¹ In other words, the vast majority of people who attempt day-trading are not successful enough to last more than a year.
3. Active traders underperform by 6.5% annually.² This paper’s authors found that the traders who trade the most earned 11.4% annually versus a market-based return of 17.9%. That is, most active traders would be better off investing in an S&P500 index fund and leave it at that.³
4. 95.3% of unprofitable day traders continue trying to day-trade.¹ Unprofitable traders with more than 50 days of day-trading experience continued trading, which implies that perhaps they are not figuring out that they are not good at day-trading. Or that hope springs eternal? The same paper found that “nearly 3/4ths of day-trading volume is generated by unsuccessful day-traders with at least 10 days of day trading experience.”⁴

These statistics paint a grim picture for the prospective day trader. The odds are very much against you. Statistics like these can shed light on what is happening, but they do not explicitly explain why. I believe most day traders fail because they act emotionally instead of rationally.

A Personal Example

I am going to share two personal experiences that demonstrate how emotional trading can doom a day trader. The first example is from twenty years ago and the second is from today.

Twenty Years Ago

I used to work as a network architect for a $4 billion/year computer company that ultimately went out of business. During their period of decline I was laid off, and I received a severance that would comfortably pay my bills for at least a year.

Being a young, smart technical person, I decided to take that time to pursue trading. I had what I thought was a great idea about stock price movements that I thought would give me an edge in trading. The short version of my algorithm is that I looked for stocks that made a high-percentage move on one day and then looked at what they historically did the next day. I created a Perl program that used multi-variable regression analysis to predict future moves.

It was pretty fancy stuff (at least in my own mind) and after about six months, I was ready to try it out. I paper-traded it for about a week and it seemed to be working. Then I started trading with live money. At first, I was making a small profit each day and I felt good about it. It seemed to validate my concept.

Ultimately however, I failed and it was pretty spectacular. Here is what happened: the trading platform I was using had a live community chat feature where traders would talk, post their in and out trades, and so on. You can probably see where this is going. Soon, I was drawn into the hype. Someone would post something and others would jump in. After a while, I was not using my system much at all in favor of winging it based on momentum and rumors and the chat. I was constantly chasing the big win and I became known as the guy who was not afraid to go short, which fed my ego.

This all worked for a while, but I started violating more of my own rules. First it was going outside my system. However, I also hated to take any loss at all. This is known as fear of regret, or regret theory. Traders become emotionally invested in their entry price point and will hang on to a position in order to avoid taking a loss even when it might be better to get out in order to avoid even larger losses.

I had a rule that I would not hold a position overnight, but then I had positions which were not profitable by the end of the day. “Let’s see what happens in the morning,” I told myself, and soon I had positions that were even deeper in the red.

You can guess what happened. The market had one of those bad days and I got into a margin call situation. I was logged in and suddenly, all my positions were being closed out, and not by me. My broker had taken action to protect themselves. I ended up losing about $45,000 which was pretty much everything I had at that point.

I will not go into the emotional damage that experience caused, but it was pretty severe. My dream of day-trading myself to wealth and riches was gone in an instant, and I had to get a job and go back to work.

Today

If you have read any of my other articles or visited my web site, you know that I learned about options trading about ten years ago and that options are my focus these days. I have been very successful with options trading, mostly by being conservative and relatively methodical.

About a week ago however, I decided to do some very limited day-trading based on a bearish volatility thesis. It has worked out well so far, but I find myself with some of the same emotional tendencies that hamstring most traders.

Take a look at the chart below:

I look to short this asset after a run up (green bars) and then buy-to-cover when it reaches a bottom and turns back up again. The red and green shaded area is a position that is open as I write this article. The following diagram shows a zoomed in view of my entry point:

I have a couple of rules for entry points:

1. At least three strong green bars or at least five trending-up green bars before a reversal (peak).
2. Do not enter the short until a second red bar indicating an established downward trend.

Rule #1 was satisfied as there were seven green bars before it turned red. However, I violated Rule #2 by not waiting for the second red bar, and three hours later I am still stuck in this losing trade.

Why did I violate my own rules? There are a couple of reasons: first, I was not able to login until two minutes before the market opened because my young children were fighting and I was mediating. Just normal, everyday stuff, but I felt rushed by the time I got to my desk.

Then, this asset took a wonderful dive right after open but I missed it because I was not ready. Ideally, I aim to make $.13 or more on each of these trades and just the initial opening drop was over $.60. I was upset that I missed out on that initial trade as that would have fulfilled my daily target of .30-.50 in just the first ten minutes of trading.

Then, that big drop made me a bit gun shy for the next couple of cycles so I missed those as well. I could feel my frustration building and for a while, the asset stayed in a relatively narrow band and there were no opportunities which did not help my focus.

Finally, I made one successful trade for a $.06/share profit and I was starting to feel better. However, I still had a strong undercurrent of FOMO (Fear of Missing Out) because of the first hour. So when that red bar appeared after a decent run up (and keep in mind the red bar was longer when I entered the trade but then pulled back) I impulsively decided to jump in. The trade was preloaded and just a mouse click away. I was not going to miss out on yet another glorious drop!

You can see what happened next. That single red bar was a short consolidation before another move up. It has been above my entry point ever since. The worst part of this mistake is that I missed out on multiple additional trades because I am stuck in this one. For risk management and margin reasons, I only put on one trade at a time.

Here is the the original chart again, but this time I highlighted the areas where I likely would have entered and exited trades.

In the timespan shown, I missed out on three trades with a potential profit of approxinately .59/share. There have been at least four more of these in the time period beyond the chart, but you get the idea.

How to Not Lose

There is a common thread in both of my personal mistakes and I believe the same issue is common to most traders: managing emotions and not following your own rules. I will delve into this in more detail below, but here is a related article as well about the personality traits that successful traders need to have:

Managing your emotions and sticking to your rules is far more important than learning technical analysis or fundamentals or almost anything else. Are those math and trading skills important? Yes, certainly, but if you make emotion-based mistakes then none of those skills matter because you will undermine yourself and that will eventually catch up to you. You will end up being one of the 98% of unsuccessful traders rather than the two percent who can do this for a living for as long as they enjoy it.

I will leave you with one more chart that shows what occurred as I finish up this article:

Look at that beautiful cliff! Today could have been an epic day, but for that one mistake. I am an experienced individual trader and I know the effect emotions have on human thinking and yet I still got caught by them. Unless you’re a robot, managing your emotions might be the toughest skill you acquire.

I encourage you to follow these two rules in all your trading activities:

1. Learn to recognize your tendencies and emotional tells and consciously point them out to yourself when you detect them.
2. Follow your own trading rules without exception!

Trust me, I’m going to follow these two rules religiously going forward. Starting tomorrow!

Prologue

In case you are wondering, I finally exited the trade eleven minutes before the regular trading session closed. I bought-to-cover at 19.46 for a profit of $.18. I cannot complain as it was a successful day (total profit of $.24/share between the two day trades) but it would have been 3–4 times as much if I followed my own rules.

Live and (hopefully) learn.

Want to Learn More About Options?

Tim Garlick has been investing and trading stocks and options for over 25 years. Visit Tim’s site at The Options Hive, where you’ll find free education, tools and resources to learn more about stock options trading.

Other Articles by Tim That You Might Enjoy:

¹ Brad Barber et al. (2017), Do Day Traders Rationally Learn About Their Ability?

² Brad Barber and Terrance Odean in The Journal of Finance (2000), Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors

³ The referenced paper is about active investors and not specifically about day-trading, but one might reasonably extrapolate the results such that the more actively one trades, the more one would underperform. Note also that the underperformance was higher during the paper’s data period because transaction costs were much higher than they are today.

⁴ Barber et al., Do Day Traders Rationally, p.5