I have read all of these disclaimers about day trading emphasizing how experienced and cautious you have to be. But I don't see how it's any different than buying a stock at a low price and holding on to it for some months.
The principle is the same isn't it? Go long when it's low or short when it's high (and you anticipate it going up or down). Why can you lose more money day trading? Is it just the psychological/addictive aspect of it?
Over a period of time greater than 10 years (keep in mind, 2000-2009 ten year period fails, so I am talking longer) the market, as measured by the S&P 500, was positive. Long term, averaging more than 10%/yr.
At a 1 year horizon, the success is 67 or so percent. It's mostly for this reason that those asking about investing are told that if they need money in a year or two, to buy a house for instance, they are told to stay out of the market.
As the time approaches one day or less, the success rate drops to 50/50. The next trade being higher or lower is a random event.
Say you have a $5 commission. A $10,000 trade buy/sell is $10 for the day. 250 trading days costs you $2500 if you get in and out once per day. You need to be ahead 25% for the year to break even.
You can spin the numbers any way you wish, but in the end, time (long time spans) is on your side.
Day trading is probably the most often tried and failed activity in the financial world. People think they can parlay $1,000 investment into $1,000,000 in a week with little or no knowledge on how to evaluate stocks and or companies. They think they can just look at where the line graphs' been and forecast where it's going to be next week. Unfortunately if it were that simple everyone would be making money hand over fist in the market.
So in short, the reason day trading is considered a risky venture is because most of the people that attempt to do it are willfully ignorant. They intentionally choose not to read about day trading. They intentionally choose not to learn about how to read a company's financial report and they intentionally choose not to learn how to compare one stock to another. They also don't consider the fact that most of their data is 15 or more min old because of the shady rules brokers have worked into the system.
Real everyday investors that make money in the market do it by careful evaluation of the purchase they are about to make. Guess what, even they lose time to time. That's the game!
Often times the commission fees add up a lot.
Many times the mundane fluctuations in the stock market on a day to day basis are just white noise, whereas long term investing generally lets you appreciate value based on the market reactions to actual earnings of the company or basket of companies.
Day trading often involves leverage as well.
Day trading is an attempt to profit on high frequency signal changes. Long term investing profits on low frequency changes. What is the difference?
High Frequency Signal = the news of the day. This includes things like an earnings report coming out, panic selling, Jim Cramer pushing his "buy buy buy" button, an oil rig blowing up in the ocean, a terrorist attack in some remote region of the globe, a government mandated recall, the fed announcing an interest rate hike, a competitor announcing a new product, hurricanes, cold winters, a new health study on child obesity, some other company in the same sector missing their earnings, etc. Think daily red and green triangles on CNBC: up a buck, down a buck.
Low Frequency Signal = The long term effectiveness of a company to produce and sell a product efficiently plus the sum of the high frequency signal over a long period of time. Think 200 day moving average chart of a stock. No fast changes, just, long term trends. Over time, the high frequency changes tend to negate each other.
To me, long term investing is wiser because the low frequency signal is dominated by a companies ability to function well over time. That in turn is driven by the effectiveness of its leadership coupled with the skill and motivation of its employees. You are betting on the company and its people. Pseudo-random shorterm forces, which you can't control, play less of a role.
The high frequency signal, on the other hand, is dominated by sporadic and unpredictable forces that typically can't be controlled by the company. It has some tinge of randomness about it. Trying to invest on that random component is not investing at all, it is gambling (akin to "investing" in that next coin flip coming up heads)
I understand the allure of high frequency trading. Look at the daily chart of a popular stock and focus on the up and down ticks. Mathematically, you could make a killing if you could just stack all those upticks on top of each other. If only it was that easy.
Largely, because stock markets are efficient markets, at least mostly if not entirely; while the efficient market hypothesis is not necessarily 100% correct, for the majority of traders it's unlikely that you could (on the long term) find significant market inefficiencies with the tools available to an individual of normal wealth (say, < $500k).
That's what frequent trading intends to do: find market inefficiencies. If the market is efficient, then a stock is priced exactly at what it should be worth, based on risk and future returns. If it is inefficient, then you can make more money trading on that inefficiency versus simply holding it long. But in stating that a stock is inefficient, you are stating that you know something the rest of the market doesn't - or some condition is different for you than the other million or so people in the market. That's including a lot of folks who do this for a living, and have very expensive modelling software (and hardware to run it on). I like to think that I'm smarter than the far majority of people, but I'm probably not the smartest guy in the room, and I certainly don't have that kind of equipment - especially with high frequency trading nowadays.
As such, it's certainly possible to make a bit of money as a trader versus as a long-term investor, but on the whole it's similar to playing poker for a living. If you're smarter than most of the people in the room, you might be able to make a bit of money, but the overhead - in the case of poker, the money the house charges for the game, in the case of stocks, the exchange fees and broker commissions - means that it's a losing game for the group as a whole, and not very many people can actually make money. Add to that the computer-based trading - so imagine a poker game where four of the eight players are computer models that are really good (and actively maintained by very smart traders) and you can see where it gets to be very difficult to trade at a profit (versus long term investments, which take advantage of the growth in value in the company).
Finally, the risk because of leverage and option trading (which is necessary to really take advantage of inefficiencies) makes it not only hard to make a profit, but easy to lose everything. Again to the poker analogy, the guys I've known playing poker for a living do it by playing 10-20 games at once - because one game isn't efficient enough, you wouldn't make enough money. In poker, you can do that fairly safely, especially in limit games; but in the market, if you're leveraging your money you risk losing a lot. Every action you take to make it "safer" removes some of your profit.
I think, the top three answers by Joe, Anthony and Bigh are giving you all the detail that you need on a technical sense. Although I would like to add a simple picture that underlines, that you can not really compare day trading to long-term trading and that the addictive and psychologic aspect that you mentioned can not be taken out of consideration.
The long term investor is like someone buying a house for investment. You carefully look at all offers on the market. You choose by many factors, price, location, quality, environment, neighborhood and extras. After a long research, you pick your favorites and give them a closer look until you finally choose the object of desire, which will pay off in 10 years and will be a wise investment in your future. Now this sounds like a careful but smart person, who knows what he wants and has enough patience to have his earnings in the future.
The short term investor is like someone running into the casino for a game of black-jack, roulette or poker. He is a person that thinks he has found the one and only formula, the philosopher's stone, the money-press and is seeking immense profits in just one night. And if it does not work, he is sure, that this was just bad coincidence and that his "formula" is correct and will work the next night. This person is a pure gambler and running the risk of becoming addicted. He is seeking quick and massive profits and does not give up, even though he knows, that the chances of becoming a millionaire in a casino are quite unrealistic and not better than playing in a lottery.
So if you are a gamer, and the profit is less important than the "fun", then short term is the thing for you. If you are not necessarily seeking tons of millions, but just want to keep your risk of loss to a minimum, then long term is your way to go.
So it is a question of personality, expectations and priorities.
The answer why losses are bigger on high frequency signals is answered elsewhere. But I am convinced in reality it is a question of what you want and therefore very subjective.
I have worked for both.
I have worked for a portfolio company that has gone through periods of ups and downs, but on the long term has made a very tempting profit, which made me regret, that I did not ask for shares instead of money as payment. These people are very calm and intelligent people. They spend all their time investigating and searching for interesting objects for their portfolio and replace losers with winners. They are working for your money and investors just relax and wait. This has a very serious taste to it and I for my part would always prefer this form of investment.
I have worked for an investment broker selling futures. I programmed the account management for their customers and in all those years I have only seen one customer that made the million. But tons of customers that had made huge losses. And this company was very emotional, harsh, unpersonal - employees changing day by day, top sellers coming in corvettes. All the people working there where gamblers, just like their customers. Well, it ended one day, when the police came and confiscated all computers from them, because customers have complained about their huge losses. I am glad, that I worked as a remote developer for them and got paid in money and not in options.
So both worlds are so different from each other. The chances for bigger profits are higher on day trading, but so are the chances for bigger losses - so it is pure gambling. If you like gambling, split your investment: half in long term and other half in short term, that is fun and wise in one. But one thing is for sure: in over ten years, I have seen many customers loosing loads of money in options in the future markets or currencies. But I have never seen anyone making a loss in long term portfolio investment. There have been hard years, where the value dropped almost 30%, but that was caught up by the following years, so that the only risk was minimizing the profit.
All forms of liquid investing necessarily have the same expected value. If any one form were more profitable, money would flood in, equalizing it.
Day trading is unusual in two key ways.
First, although the expected value is the same, the risk profile is very different.
For example, would you wager a dollar on the flip of a coin? You might. Why not, after all? Would you wager a million dollars? Probably not. The risk is too great.
Similarly, day trading can easily lose you all of your investment, which is why you should be careful doing it.
(In his memoirs Liar's Poker, Michael Lewis tells an anecdote about a rich bond trader who proposes a million-dollar, even-money bet with his rival, an amount both could just barely afford to lose. The rival, not wanting to play but not wanting to lose face by declining, accepted.. with the proviso that the stakes be raised to 10 million dollars! The trader backed down.)
Also, the efficient market only guarantees the price will be efficient. It says nothing about transaction costs. A busy day-trader can easily incur thousands in commission and other fees.
But I don't see how it's any different than buying a stock at a low price and holding on to it for some months.
Based on your question, I would say the difference is time.
Day trading by its nature is a 6-hour endeavor. If you buy low and are planning to sell high, then you only have a few hours to make this happen. As a previous poster mentioned, there is a lot of "white noise" that occurs on a weekly/daily/hourly/min basis.
Long-term investors have the time to wait it out. Although, as a side note, if you were a buy-and-hold investor from the 1960s-early 1980s, then buy and hold was not very good.
Is it just the psychological/addictive aspect of it?
This is the biggest reason. Day trading is stressful and stress can cause financially destructive decisions such as over-leveraging, over-trading, etc.
Why is day trading stressful? Because you are managing hundreds to thousands of trades a year. When combined with the lack of time in a day to make moves, it becomes stressful. Also, many day traders do it full time. Which adds to the pressure to be correct and to be incredible at money managment. A lot of buy-and-hold investors have full time jobs and may only check their positions every month or so.
Well, let me take your question for baremetal, and aknowledge you did not asked about the difference between daytrading and investing which is obviously leverage.
I would not consider daytrading more risky as long as you keep leverageout of the equation.
Daytrading can be turbolent and confusing, where things unfold in a very short amount of time, (let trade nfp payroll or some breaking event, yay), eventually the risk is more overseeable in long term trading, as soon as you put leverage into the equation things look vary different, indeed.
In day trading, you're trying to predict the immediate fluctuations of an essentially random system.
In long-term investing, you're trying to assess the strength of a company over a period of time. You also have frequent opportunities to assess your position and either add to it or get out.
Short-term, the game is supply/demand and how the various participants react to it at various prices. On longer term, prices start to better reflect the fundamentals. Within something like week to some month or two, if there has not been any unique value affecting news, then interest, options, market maker(s), swing traders and such play bigger part.
With intraday, the effects of available liquidity become very pronounced. The market makers have algos that try to guess what type of client they have and they prefer to give high price to large buyer and low price to small buyer. As intraday trader has spreads and commissions big part of their expenses and leverage magnifies those, instead of being able to take advantage of the lower prices, they prefer to stop out after small move against them. In practise this means that when they buy low, that low will soon be the midpoint of the day and tomorrows high etc if they are still holding on. Buy and sell are similar to long call or long put options position. And options are like insurance, they cost you. Also the longer the position is held the more likely it is to end up with someone with ability to test your margin if you're highly leveraged and constantly making your wins from the same source.
Risk management is also issue. The leveraged pros trade through a company. Not sure if they're able to open another such company and still open accounts after the inevitable.
It's important to distinguish between speculation and investing. Buying something because you hope to make money on market fluctuations is speculation. Buying something and expecting to make money because your money is providing actual economic value is investing.
If Person A buys 100 shares of a stock with the intent of selling them in a few hours, and Person B buys 100 shares of the same stock with the intent of holding on to it for a year, then obviously at that point they both have the same risk. The difference comes over the course of the year. First, Person B is going to be making money from the economic value the company provides over the whole year, while the only way Person A can make money is from market fluctuation (the economic value the company provides over the course of an hour is unlikely to be significant). Person B is exposed to the risk of buying the stock, but that's counterbalanced by the profit from holding the stock for a year, while Person A just has the risk. Second, if Person A is buying a new stock every hour, then they're going to have thousands of transactions. So even though Person B assumed just as much risk as Person A for that one transaction, Person A has more total risk.
