Can you still make money from day trading?
Day trading is one of the riskiest ways of putting money into assets such as shares, commodities and foreign currency. But the flipside is that the potential returns can be significantly higher than more traditional forms of investing.
Strictly speaking, day trading means taking a position on an asset and then closing it out on the same day, with the aim of making a quick profit. The practice has been around for several decades – day trading began in the UK in 1974 when a group of bankers led by Stuart Wheeler set up IG Index to allow investors to speculate on the price of gold.
But the concept really took off towards the end of the Nineties thanks largely to the spread of the internet, which made it far easier to get information and to execute trades quickly, and the dotcom bubble, which ran from around 1997 to the spring of 2000. During that period, it wasn't just easier to trade - soaring share prices meant that day trading also appeared to be extremely lucrative.
But even in the years before the tech bubble burst, short-term trading was far from a one-way bet: as well as anecdotal evidence of huge instant gains made by private investors, there were numerous stories of massive losses suffered by people who could not afford them.
In the summer of 1999, several months before the crash, the North American Securities Administrators Association (NASAA), a US investor protection organisation, published a report warning of the dangers of day trading. Its research found that 70% of private traders would "almost certainly lose everything they invest". And only 11.5% of the day-trading accounts studied by the NASAA showed "the ability to conduct profitable short-term trading".
In the immediate aftermath of the dotcom bust in March 2000, the popularity of day trading waned on both sides of the Atlantic. But today, this approach to investment is in rude health, with participants either buying and selling shares directly through a wide range of online brokers or using the growing number of spread- betting platforms to leverage their investments.
Jonathan Cumberlidge, head of sales at trading platform CityIndex,says: "Theappeal of trading continues to grow as people are becoming increasingly financially savvy and self-directed. It is no longer exclusively the domain of financial professionals and we have customers from all walks of life.
"As we have been experiencing long-term low interest rates, many retail investors are unhappy with the returns they make from regular savings products, and trading offers an accessible way to try to make a larger return on investment."
There are now more websites and blogs analysing companies and stockmarkets than ever before: private investors certainly have no shortage of information. And the growth of mobile internet and investment apps means that day traders no longer need to sit at a desk for hours on end, monitoring price movements.
So how do you take your first steps in day trading? Patrick Connolly at independent financial adviser Chase de Vere says: "Anyone can engage in day trading, in much the same way as anybody can open an online account with a bookmaker and bet on the horses.
"But the starting point needs to be determining what you want to achieve: are you looking at day trading as a new career where you'll be relying on profits to pay for your day-to-day living costs? Or is it just a hobby where you'll be 'playing' with money that you can afford to lose?"
Leslie adds: "The best way to get first-hand experience of trading is to open a demo trading account with your broker; it's no different to real trading, except you are using it as a practice account, rather than using your money.
"The commitment for day trading will depend on how regularly you trade and the strategies and instruments you want to adopt. It is important for anyone interested in trading to develop a strong fundamental understanding of how the financial markets work and the most important characteristics of various trading strategies, asset classes and instruments on offer. Some retail investors trade as a hobby, some do it part time, and for others it is a full-time profession."
Malcolm Stacey, a financial journalist and author of Share Attack, a new book on getting started in trading, says that it is vital that day traders are ready to close out their positions at a moment's notice. "You need to keep your screen open all the time, with your sell button poised, and you should pay for an online real-time share-value service. Most brokers offer a free share movement service, but they are 15 minutes delayed. You actually need real time to be safe."
Real-time share prices are available from the likes of Moneyam.com and ADVFN – both sites offer a basic free service, with the option to upgrade to get alerts on specific stocks or access to bulletin boards used by other traders.
Your trading options
You also need to decide whether to trade directly in shares or use a spread-betting platform.
Spread betting allows you to speculate on the movement of shares, stockmarket indices or exchange rates, say, over a fixed period. For example, you might expect the FTSE 100 to rise on a particular day, so you could buy a stake of £5 per point. If the index rises by
50 points above the 'buy' price, you would make £250; equally, if it finished 50 points below, you would lose £250.
With spread betting, you don't own the underlying asset and your position is leveraged – which means gains or losses can be far greater than any initial stake or deposit. (With spread bets, you can also profit from falls in value.)
By day trading directly in shares through a broker, your potential losses are limited to the value of your holdings.
Your tax position
There are some tax advantages to spread betting, Stacey says. "Ordinary day trading – buying and selling shares via an online broker – means you have to pay stamp duty and spread on the purchases. You may also have to make detailed records for capital gains purposes.
"If you spread bet, you avoid stamp duty and capital gains tax, though you still have a spread to pay. Most day traders now would do it through spread betting."
Some brokers will allow you to trade shares within a stocks and shares Isa, which means you can invest up to £15,240 a year without any subsequent gains being subject to capital gains tax. Any dividends you receive will be recorded by your broker – higher- and top-rate taxpayers will need to declare them unless the shares are held in an Isa.
Plan your trading strategy
It is also worth thinking about what your approach to trading is going to be. "The best strategy is to use self-discipline," says Stacey. "Set a target to which you expect the share to rise and sell at that point. Don't wait, hoping for more.
"Pick shares that are already rising: the trend is your friend. If a share starts the day on the up it will usually continue to shine. But sell at the day's end at the latest – a day trade can easily become a long-term trade if it loses money on the first day, because you are loath to sell a loser. But sell it anyway, because the day after a big leap for a share often sees the stock fall back to where it was – or worse."
Some traders use technical analysis to help them make buying and selling decisions – for example, they may believe that a particular share has a short-term "price ceiling", that is, a level above which it is unlikely to rise in the near future, for example £1 or £5.
This may lead them to sell as the price approaches the ceiling. Some day traders use historical analysis of stockmarkets, slavishly adhere to a bewildering array of predictive charts, or use the words of famous economists as gospel.
Indeed, another method is to trade based on news, either concerning specific companies or the economy in general. However, Connolly warns: "Professional fund managers, backed by huge investment research resources, cannot be relied upon to consistently make the right short-term tactical decisions, so what chance does somebody sitting at home in front of a computer screen really have?"
It is also possible to put 'stop loss orders' on trades or spread bets: this means that if an asset falls to a pre-determined level, your position is automatically closed. But this is not a fail-safe method, Stacey warns: "Sadly, stop-loss systems do not always work. A manual share selling action is best."
Weigh up the risks
Would-be day traders need to consider the risks, Connolly says. "Even when day traders make profits, it could be that buy-and-hold investors would have achieved better returns with much less effort, in part because their dealing costs are likely to be much lower.
"While the prospects of making big gains could be appealing, much like betting on the horses, for most people it makes absolute no sense to invest money they cannot afford to lose."
Robbie Burns, author of the Naked Trader blog and several books on investment strategy, is even more forthright. "Prospects are terrible for new day traders," he says. "At least 95% will lose their money over time. Day traders are battling with robot computers, clever algorithms and companies that have spent millions trading in mega amounts.
"How any would-be day trader thinks they can possibly beat the casino is beyond me. There may have been a chance of making some money doing it many years ago. Not now."
Burns says that medium-term investment is likely to be a much more suitable strategy. "This means finding very good companies that pay good dividends, as well as realising that making money takes time," he explains. "One also has to learn discipline: that is, the ability to cut losers quickly and the patience to run winners for a long time."
Allows you to bet, or take a position, on whatever you think a financial market will do next. The more the market moves in your favour (up or down), the more you profit, with unlimited potential. Similarly with losses, if the market moves against you. A spread betting company will offer a quoted “spread” on an index, share or even elements of a sporting fixture. If you think a market is set to rise, you ‘buy’ at the top end of the quote (the offer price), or if you think the market will fall you ‘sell’ at the bottom of the quote (the bid price). All gains are tax-free but you will have to deposit money with the spread betting company to cover any losses and if your losses exceed that, the company will demand more money to cover your loss-making position. Spread betting is risky; it’s for people who know what they’re doing rather than for novices.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
The difference between two currencies; specifically how much one currency is worth relative to each other. For example, if £1 is worth $1.50, converting sterling to US dollars, the exchange rate is 1.5. Converting dollars to sterling at those levels, the exchange rate is 0.66, so $1 is worth 66p. There are a wide variety of factors that influence the exchange rate, such as a country’s interest rates, inflation, and the state of politics and the economy in that country.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.