It’s not hard to see why people flock to day trading, especially in boom economies. The opportunity to work for oneself and pit one’s wits against the market is exciting — and there seem to be so many ways to make huge amounts of money quickly in the stock market.
That’s true enough: Many people do make staggering amounts of money over short periods of time on the stock market. Of course, lots of people also lose money — and more than a few people make money and then lose it (or vice versa). The stock market tends to go up over time, but its fluctuations in the short term can be dangerously unpredictable. That makes day trading a risky proposition — but there are ways that you can limit your risk. Here are some of the dangers that come with day trading, along with tips for keeping those dangers at bay.
You could lose money
Let’s start with the obvious: Day traders sometimes lose money. Even if you generally succeed as a day trader, you can expect rough days, rough weeks, and even rough months. You will sometimes have to go without an income, and you will sometimes actively lose money.
This is pretty much unavoidable, so your goal should be twofold. You should aim to make more money than you lose over the long term, of course — that’s goal No. 1. Goal No. 2 is to make sure that you have a good emergency fund on hand to help you get through the tough times without having to cash out good positions or take out a loan.
Gambling psychology could work against you
Investing is not the same thing as gambling, of course. But when it comes to risky speculative moves of the sort that some day traders make, the distinction can become dangerously blurred.
Gambling has power over us because of how the rush of winning and the fear of losing affect our brains. If you’re not careful, you could end up chasing losses or getting greedy with your positions on the market for all of the same reasons that gambling addicts keep pulling the slot machine lever.
Try to stay clearheaded. Rely heavily on your strategies and rules, and minimize the number of times that you’ll have to make a judgment call or rely on a “gut feeling.” Use stop/loss orders to minimize losses, and set boundaries for yourself just as you would at the casino.
You could misunderstand your own strategy
What trading strategy are you going to use? Whether you’re using a heikin ashi strategy or a simple P/E calculation, you need to know exactly what you are doing — and you need to understand why.
As a day trader, you’re responsible for more than a typical passive investor is. You really need to know your stuff, and you need to be able to make split-second decisions with big consequences and know that the call you’re making is supported by the math and strategies that you’ve chosen.
Take the time to learn the ins and outs of the strategies you have available to you. Take classes, test your strategies on market simulators, and do everything you can to ensure that you’re going into your high-stakes bets with the right skills.
“Market risk” is one of the major types of risk that investors face. In some ways, it’s the simplest kind of danger that a trader faces. Market risk is the risk that the whole market takes a dive. In bad economies, even good companies and stocks can suffer, and that can really disrupt your day trading strategy.
There are a lot of ways to lose money as a day trader, but becoming the victim of a big economic turnaround is a particularly frustrating one. Be sure to keep an eye on big financial news sources such as The Wall Street Journal, and be wary of large-scale market indicators. Meanwhile, keep a nest egg and emergency fund in relatively safe spots so that a market crash won’t totally clean you out.