Summary: Why Most People Should Avoid Day Trading
I truly believe that when it comes to investing, knowing a little can be more dangerous than knowing nothing at all. When I first started learning about trading, I assumed I could master everything I needed to make profitable trades within a few weeks. I didn’t yet realize the extent of my own inexperience. I believed that the information I was consuming gave me a unique edge and that I could simply outsmart everyone else in the market.
It wasn’t until I gained more exposure in the industry and began studying the markets in depth—both on my own and through the CFA curriculum—that I began to understand just how complex investing really is.
If you’re considering testing your stock-picking skills through day trading, here are some key risks to keep in mind before you get started.
1. Consider the strength of your day trading competition.
Would you step into a boxing ring without knowing who your opponent is? Every trade you make has someone on the other side. But who exactly are you up against? Is it someone like you, working from a home office, making decisions based on CNBC segments and SEDAR filings? Or is it a Wall Street hedge fund using sophisticated algorithms, elite analysts, and high-speed infrastructure to exploit price inefficiencies that last for mere milliseconds?
Like any competitive pursuit, you need to consider the strength of your opponent before deciding to day trade. At its core, trading is a zero-sum game—you believe a stock will move one way, and the other party believes the opposite. Because trading is anonymous, it’s easy to forget there is always someone else involved. Don’t assume that your perspective is the smart one. The other side might be better informed, faster, and far more experienced.
2. Short-term trades may have different tax implications.
Some recent shifts in the investing industry have made the idea of more frequent portfolio turnover more appealing. An example of this is that many brokerages are moving to commission-free trading. However, punitive as they may be collectively, your decision to buy or sell shouldn’t be too heavily influenced by a $9.99 trading commission. Rather, more emphasis should be placed on the tax implications of day trading. The revenue generated from day trading may be considered as business income in Canada. This means that 100% of your capital gains will be taxed as income and subject to your current tax rate, rather than deducting 50% of capital gains if you are an ordinary investor (your losses are also 100% tax deductible, but this concession likely won’t be too comforting. You don’t want your day trading to be a loss-generating endeavour).
Even if you are day trading in a registered account (such as an RRSP or TFSA), your profits may still be taxed as business income. The CRA does not permit these accounts to be used to carry on a trading business. While TFSAs and RRSPs are intended for long-term, tax-sheltered investing, frequent or aggressive trading can lead to a reassessment. If the CRA determines your activity qualifies as business income, the tax-free or tax-deferred status of your gains can be lost, and the full amount may become taxable.
3. You will be tempted to act on incomplete information.
In some ways, investing is a lot like fishing in that the key to success is patience. Once the hook is in the water, your primary responsibility is to do nothing but enjoy the sounds of nature. Likewise, you should spend the majority of your time doing nothing with your investable funds. Establish the proper asset allocation, invest your funds accordingly, and then rebalance based on pre-established rules and/or timelines.
Day trading flies in the face of this virtuous patience. With day trading, you are sitting at your desk, staring at your wall of monitors. Your Bloomberg terminal is steadily quoting prices from all major exchanges and every position you follow. With all this stimulation, you feel compelled to take action. This temptation to do something, no matter how ill-conceived, can be the path to financial ruin.
4. You will enter and exit positions based on emotion.
Many people are subject to the bias known as loss aversion, whereby a loss of funds feels roughly twice as bad as an equivalent gain feels good. Loss aversion can be particularly destructive when it comes to investing. It often leads people to sell their winners too early and let their losers run for too long with the hope that they will come back. It reasonably follows that spending increased time staring at your positions will make you more likely to act in conjunction with this bias.
You may think that you won’t fall into the same traps that other day traders do, that you are immune to the biases that plague your competitors. Just remember, they all feel the same way about themselves. Not everyone can be right.
There is one advantage I would highlight when it comes to frequent trading: sometimes the best way to learn is by losing money. It is extremely humbling to spend hours researching positions and put your hard-earned money to work just to see it evaporate. It is the pain of losses that spurred me to learn as much as I could about investing and personal finance. With that said, just make sure that you aren’t day trading with anything that you can’t afford to lose.
Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.
