4 Reasons Day Traders Lose Money
By studying their mistakes, we may be able to avoid their fates ourselves. Here are four reasons why day traders lose money.
Day trading can be a very lucrative profession. When things go right, day traders can make incredible amounts of money in very short periods of time, far outpacing more casual investors. But day traders can also lose big. In fact, most experts believe that the majority of day traders—perhaps even a supermajority—lose money.
But how is it that a profession so lucrative also results in the downfall of many others? As it turns out, there are a few reasons that rookie day traders lose big bucks.
They dive right in.
Without a strategy, you'll have a serious problem making money consistently as a day trader. And even if you have a strategy, that doesn't mean you have a proven one.
Smart day traders test their strategies on stock market simulators and really hone their skills before they mess around with real money. This is one of those situations in which discretion is the better part of valor! It may be frustrating to watch your strategies work without making real money, but you'll be happy to know for sure if they do before you put your hard-earned money at risk.
They trade with their gut.
As a day trader, your strategy is your best friend. Every day before the market opens, you should be going over your rules of engagement, even if only in your head. You should know exactly what you will and won't do in given situations because you never want to be relying on gut feelings and hunches.
Day traders deal with lots of stress and volatile situations. They can easily be tempted to chase losses or hold onto a stock that they shouldn't. When you have a clear strategy to turn to, you can avoid the very real dangers that come with making passionate decisions under stress. Let logic, not your emotions, make your decisions. Draw on your strategies and your tools. Use the ATR indicator or the momentum chart and deal with pure, impartial numbers. When you do, you'll end up making more money as a day trader.
They over-leverage themselves.
Day traders may have access to margin accounts—in other words, they may be able to borrow money from their brokerage in order to buy stocks and other investment vehicles. That's great, but be very careful about taking out too much debt. Being over-leveraged is never a good thing. Brokerages will charge significant interest on your margin loans, and you'll have to pay those loans back regardless of whether or not you're able to make money with the borrowed cash. Always be mindful of your risks and your margin buys.
They mess around with penny stocks.
In the stock market, volatility and risk are related to opportunity. The more a given stock or other investment vehicle can move in value over a short period of time, the more money you can make—or lose. The ultimate in volatility are so-called "penny stocks," super cheap stocks in companies with small market caps. So if you want to make crazy money, you should target those—right?
Well, not really. Trade penny stocks at your own risk. They are highly volatile investments that are prone to clever moves by folks with a lot more cash at their disposal than you have. Buying a penny stock is like shorting the lottery—and shorting one is financial suicide. Be very careful, and try to avoid penny stocks entirely if you can.