Day trading is an investing strategy in which you buy shares of stocks for one price, then sell them for another price before the market closes. Because of the potential to earn big gains in a single day, as well as the low trading fees on online brokerages, day trading has become fairly popular over the years, with people even quitting their jobs to try and hit it “big” in the day trading business.
But we’ll be straight with you. While day trading could be a lucrative venture for some, it can be a disastrous waste of money for others. Most day traders lose money, not because they don’t know the market, but because it’s extremely hard to guess the market right every time.
So what exactly is day trading, how does it work, and what are the risks? Let’s take a closer look.
What is day trading?
Day trading involves making numerous stock trades in a short period of time, usually a single day, to capitalize on price movements.
For instance, a day trader may have reason to believe that Stock A’s price will rise in a few hours. When the market opens, this trader buys 1,000 shares of Stock A at $30 per share. Then, he waits. At a certain point, Stock A’s price jumps to $30.10 per share, and this trader sells his entire holding. Off this one trade, he makes $100 before taxes.
As you can see, day trading is very different from investing (there’s a reason it’s not called “day investing”). When you invest money, you typically leave it in a security for the long-haul. To investors, it doesn’t matter if the market goes up or down. What matters is that the average return on investment (ROI) shows an upward climb over a long period of time.
How does day trading work?
At its core, day trading is about taking full advantage of how the market fluctuates in a single day. For many day traders, it doesn’t matter if the price of a particular stock makes an astronomical leap or an infinitesimal one. In fact, many day traders make their profits on very small changes in a stock’s price (also called “scalping”). The idea is that by buying a stock in bulk, a small change in the price of a single share could represent a major profit in the combined price of all.
In addition to scalping, day traders employ a variety of strategies and techniques to maximize short-term gains. Some investors comb through news stories, press releases, and company announcements, hoping to find some news that will change a particular stock’s price. Others pay close attention to price movements when the market opens (when orders are executed and prices shift the most), then act accordingly. Still others might take a contrarian approach and buy stocks they deem underestimated by the crowd.
What are the risks of day trading?
We’ll be blunt: most day traders lose money. In fact, perhaps the greatest risk of day trading is underestimating how difficult it is to make significant gains over the long-term. The strategy sounds simple. Buy stocks, wait for the price to go up, then sell for a quick gain. But this seemingly simple tactic is teeming with complications, the most lethal of which is the very foundation of day trading — market volatility.
No day trader, not even the most professional, can predict with a high degree of accuracy what the market will do. You can analyse financial statements, read company announcements, watch the market like a hawk. But, at the end of the day, the hours you put into day trading could cause you to lose money. Imagine having a job where your employer makes you pay them for the work that you do. That’s how day trading can feel for those who get burned out.
Speaking of employers, it’s worthwhile to note that day trading, if you are to be successful, is not a hobby. It’s not something you do while you’re waiting for your coffee or taking a lunch break. If you’re going to make hefty gains, especially if your goal is to save for retirement or earn a living, you need to dedicate a significant amount of time to the practice. The less you treat day trading like a part- or full-time job, the more risky it becomes for you.
How are day trading activities taxed?
Taxes and day trading can become extremely complicated (it’s taxes — what would you expect), so if you day trade frequently you should consult a tax advisor.
Essentially, the complication comes down to whether or not the Canada Revenue Agency (CRA) consider you a professional day trader.
Unfortunately, the definition of a “professional” day trader versus someone who merely dabbles isn’t bureaucratically defined. Whether or not the CRA considers you a day trader, however, typically depends on how frequently you trade, how much volume you trade within a given day, and how long you own your stocks. It also depends on how much you rely on day trading as a source of income. If day trading is a full-time job, the CRA will most likely consider you a professional.
As a professional day trader, your gains will be treated as business income, and 100% of them will be taxed at your marginal tax rate. If you’re not a professional, however, only 50% of your gains will be taxed.
Finally, it’s important to note that you cannot day trade within certain tax-sheltered retirement accounts, such as a TFSA or a RRSP. If the CRA suspects that you are evading tax responsibilities by day trading in these accounts, they will investigate, and you could end up paying taxes on your gains.
How do you find a broker for day trading?
If you’re dead set on day trading, you’ll need a brokerage who will conduct the trades. While most online brokerages allow day trading, you’ll still want to be careful about who you choose. Below are some things to look for to find a great online brokerage.
Low fees and commissions
Since you’ll be trading stocks frequently throughout the day, you’ll want to find a brokerage that charges low trading fees. The last thing you want is for high fees to eat into your gains, let alone cost you money if you end up losing money on a trade.
As a day trader, you’ll often need to take action quickly. That said, you’ll want a trading platform that uses the most advanced technology to respond and execute your trading requests.
It doesn’t matter if you’re the most professional day trader out there. At some point, you’ll need some assistance. Look for a brokerage that has stellar customer support, as well as access to research and resources.
What’s an alternative to day trading?
If day trading sounds too time-consuming and risky for you, don’t worry — you have plenty of alternatives to choose from.
Perhaps the best way to gain a significant amount of wealth is to adopt a “buy and hold” strategy. With a buy-and-hold strategy, you identify stocks or ETFs that you believe will perform well over a long period of time, anywhere from five to twenty-five years. Then, you hold them. It doesn’t matter if the stock prices go up or down. You hold your shares and stay invested.
Though, yes, you can lose money with a buy-and-hold strategy, you’re far more likely to lose it as a day trader. Even a share in the S&P/TSX Composite Index, which has a historic average ROI of 9% to 10%, would most likely give you a higher return than the quick gains of a day trade.
Is day trading worth it?
Day trading is not worth it for the majority of Canadians.
For one, earning significant profits as a day trader is a rare feat. Even if you’re a highly sophisticated investor, it’s unlikely you can time the market correctly, not to mention time it consistently over the long-run. Even if you do earn profits as a day trader, you have to factor in taxes and fees, both of which limit how much you can earn as a day trader.
The real problem with day trading is that it sounds good in theory, but rarely delivers in practice. On some occasions, you might make a trade that results in explosive gains. More than likely, you’re going to engage in an expensive guessing game that costs you more money than you ultimately earn.
You’re better off opening an account with one of Canada’s finest online brokerages and adopting a buy-and-hold strategy. You may not see high gains in the short-term, but if you choose great stocks and ETFs, you’ll likely see a steady upward climb over the long haul.