Thursday, April 19, 2012

The Profitability of Day Traders

Research on Profitability of Day trading and Day Trader
The Profitability of Day Traders
Douglas J Jordan, J David Diltz. Financial Analysts Journal.  Nov/Dec 2003. Vol. 59, Iss. 6; pg. 85


Abstract  of the paper

Day-trading profitability was studied by using data from February 1998 through October 1999 for 7 branch offices of a national securities firm specializing in day trading.

In one methodology, daily buy and sell trades were matched by the number of shares of a given order number.

 In another technique, data was sorted for a given trader by stock, then by date, and by time.

Results show that 35.8% of traders had a net profitability greater than zero after commissions and 64.2% had a net profit of less than zero after commissions. The most profitable trader made more than $197,000, and the least profitable trader lost more than $748,000.

Being a profitable day trader appears to be more difficult than the industry maintains. The implication is that aspiring and novice day traders should give careful consideration to why they think they will be among the 20% of day traders who make at least $5,000 day trading.
Lottery players/stock traders
Meir Statman. Financial Analysts Journal. Charlottesville: Jan/Feb 2002. Vol. 58, Iss. 1; pg. 14, 8 pgs
Abstract of the paper 

Lottery playing and stock trading are puzzles in standard financial theory because they are negative-sum games - games that combine high risk with negative expected returns. Lottery playing is a negative-sum game because the lottery authority keeps some of the money. Stock trading (as opposed to buying and holding) is a negative-sum game because brokers and market makers keep some of the money. So, why do people play? Perhaps all lottery players and stock treaders think they are above average, likely to win even in a negative-sum game.


"Someone is going to win the lottery," says an E*Trade advertisement. "Just not you." Stock traders poke fun at lottery buyers, but the two have much in common. Indeed, the behavior of stock traders and lottery buyers teaches us much about our aspirations, thoughts, and emotions. That behavior also helps us answer many questions of finance, such as the construction of portfolios and the nature of the equity premium.


Some Facts on Day Trading

Day traders  are defined as investors who buy and sell a stock in the same trading session at least four times a week.


Suitability requirements included a $25,000 minimum in account equity.

$25,000 minimum account equity for day traders was implemented in August 2001 for NYSE stocks and September 2001 for Nasdaq stocks (Elstein and Forster 2001). According to the SEC, the minimum requirements apply to all day traders, who are defined as investors who buy and sell a stock in the same trading session at least four times a week.



Testimony of Arthur Levitt , Chairman of the U.S. Securities and Exchange Commission, Before the Senate Permanent Subcommittee on Investigations
Committee on Governmental Affairs, Concerning Day Trading

September 16, 1999


A fundamental distinction between a day trader and a more traditional retail investor who manages investments on-line is the kind of broker-dealer through which he or she trades. The typical broker-dealer the Commission identifies as a day-trading firm advertises the day-trading services it offers along with the benefits of day trading, and solicits individuals to become full-time day traders. Most day-trading firms also teach individuals to engage in strategies based on rapid-fire buying and selling of price-sensitive stocks and then encourage these individuals to use this strategy on an ongoing basis. For a fee, some firms --or their affiliates – provide training on how to make money trading on small price movements. Day-trading firms also frequently provide their traders with proprietary software and systems that analyze and chart activity in particular stocks. Typically, day-trading firms offer these services at on-site trading facilities, rather than through Internet web sites. On-line firms, by contrast, merely offer an electronic order entry service to their customers and do not encourage the use of any particular trading strategy.

A second distinction between traditional brokerage and day-trading firms is that day-trading firms provide individuals with "real time" links to the major stock markets and the Nasdaq. These linkages give individuals substantial market information not readily available to the average retail investor and provide direct entry to the firms' order processing systems. This direct access to market-operated order execution systems allows these individuals to send their orders to a particular market or market maker. Through these systems, day traders can receive a trade execution within seconds.

Although broker-dealers are not required to identify themselves as "day-trading firms," 62 broker-dealers, with 287 branch offices, were recently characterized as day-trading firms by the North American Securities Administrators Association ("NASAA"). The Commission estimates that the number of day-trading firms, in fact, exceeds 100, and believes that there are approximately 5,800-6,800 persons trading full time through day-trading firms.
Day-trading firms use various forms of advertising to solicit potential customers. Newspapers, magazines, and web sites are among the most popular advertising mediums. These firms promote to potential day traders such benefits as "maximum leveraged capital of 10 to 1," "state-of-the-art trading systems," "after-hours trade execution capability," "maximum profit potential," and "training by experienced professionals."
Some day-trading firms promote lending between day traders to cover margin deficiencies. This practice is often referred to as journaling. Regulation T, which governs extensions of credit by and to broker-dealers, provides that a firm may arrange for the extension of credit to or for any customer by any person, provided the broker-dealer does not willfully arrange credit in violation of Regulations U or X. Traditionally, journaling has been used in rare instances when one individual – often a relative – agrees to cover the margin deficiencies of another individual. Typically, these loans are made on an overnight basis to traders who would otherwise face a margin call. The borrowers are typically charged interest of one-tenth of 1 percent daily, which amounts to 36.5 percent on an annual basis.

Special Study: Report of Examinations of Day-Trading


Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission  

February 25, 2000



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