The incredible lure of day-trading

Ah, day trading, the ultimate signal of feel-good in the markets[ref]I wrote the first draft at the end of September. The feel-good doesn’t quite ring true now – exciting times ahead?[/ref]. It’s the harbinger of doom, because it is a signal of irrational exuberance. A bunch of day-traders were on the telly a few days ago, hat-tip to Under The Money Tree who flagged up Traders – Millions by the Minute as an object-lesson in what not to do.

There are two fundamental approaches to trying to make money out of the stock market. One is to regard it a way of purchasing a selection of productive assets, and then becoming a rentier, sitting back and taking a slice of those productive assets without having to do any work. Don’t knock it -that’s the way the super-rich are getting richer. They’re not saving from income, that’s soooo 20th century, dahlink. You need to have inherited wealth or stupendous good luck. The latter is how Russian oligarchs get rich, the former is how Paris Hilton and the Ecclestone daughters got rich. You don’t get to have a pad at the Odeon Tower Monaco if you’re on the side of income no matter how clever you are or how good a footballer.

Capital, not income will get you here
Capital, not income will get you here

Half a billion is doable as income, but you need a turbo-charge from the stock market to keep you there. CEOs and the like have managed to get into this area by getting on the side of the stock market, but they don’t day-trade.

The second is to regard the stock market as a casino, and to attempt to pick a smidgen of signal from the noise the market throws off. In Traders-Millions by the Minute the punters were taking this line, using spread-betting. The Ermine has indeed had dealings with spread-betting. I’m a fan of it in dealing with sharesave, because you can lock-in profits.  Though I lost money on that side of the trade I achieved my goals. Every year I get on the wrong side of the trade with my house insurance too, and lose money. I am cool with that.

WTF? The Ermine is a fan of trading and spread-betting?

Sometimes you have to hold shares for a particular period. Sharesave and Employee Share Incentive Plans are a classic case, particularly the latter. You have to be a special kind of mug to lose money on Sharesave, but on ESIP you can, because you purchase the shares from pre-tax income but have to hold the shares for five years from purchase, else you get to pay the tax and NI you didn’t pay to buy the shares.

So say you buy 100 shares of Megacorp at £1 a share using £60 of your hard-earned cash post-tax. The £100 only costs you £60 because the taxman doesn’t thieve £40 from your income in this instance. But you have to hold those shares for 5 years. If they go down to 60p at the end of those 5 years you break even, less five years of inflation.

If you short the number of shares you buy, then you will cancel out any gain or loss on the shares, though it will cost you something to do that. But you do get the benefit of the 66% tax bung. Why 66%? Because you forgo £60, but you get £100. Thus a profit of 40/60 or 2/3 = 66%/ Less three years of inflation, say about £10, so you come down to 50% up.

I used this towards the end of my time at work with ESIP and Sharesave – to protect myself against significant falls in The Firm’s share price. As it was The Firm’s SP went up, and I got to pay IG about £1000. I was easy with that – it was worth paying to insure myself against losing a lot of what I had gained already.

Social Trading and Trading Superstars, a new development in the trading universe

Apparently you can now track some other trader’s trades if you can’t be bothered to do the legwork yourself. It really puzzles me whyit’s not obvious what’s wrong with this. The long-term rise in the stock market is roughly 5% p.a. real[ref]this comes from the BarCap Equity study[/ref] , though you have to be invested for long periods of time (about 20 years) for things to settle out like this. It’s one of the reasons why I believe index-investing’s studious ignorance of high CAPE/valuations is am issue. But that’s something for another day. So traders, every day, are exposed to  1/7300th of their stake on average in real stock appreciation if they go long, less the cost of the spread on every turn which applies going long or short.

Now trading tends to be a short-term activity – that daily gain from the stock market going long isn’t going to speak for much there at 0.01% per day. So you profits as a trader have got to come from somewhere, and it comes from either the punters or the casino your spreadbetting firm. Seen any spreadbetting firms go bust recently? Nope. So it’s coming from the punters. In theory it could come from the markets, because the SB firm presumably hedges any major shifts building up over time, but the programme seemed to indicate most of the profits were from the spreads on the trading, which stays within the system.

And therein lies the rub. If all the punters start getting ahead, the odds will lengthen. Particularly in spreadbetting, where you are running on a model of the real thing, not the underlying market.

The trick with day-trading is to quit when you’re ahead

Over a dreary telephone conference at work way back in 2010/11 an Ermine extracted £400 from IG index on gold, trading per tick, and gave up £350 of it by the end of the meeting. It was sheer luck. Some while later I dabbled in forex trading, using a VAR spreadsheet to control risk. After a few months[ref]I had a similar temperament to the timid trader in the programme, if in doubt I did n’owt. This is apparently not the route to success in this field[/ref] I looked at the results, observed how much risk it was necessary to pay the fees. I experimented with IG’s automated trading system, where you try and craft a black-box strategy based on the previous charts price history, and back-test it on historical data without using real money.

I could find no strategy that permitted risk to stay bounded as time passed – everything seemed to trend towards a martingale situation where you can always win – if you have infinite wealth and infinite time. If you have infinite reserves of wealth you don’t need to piss about with spreadbetting, cos you don’t have infinite time. I was never tempted by the breathless folks offering courses and training to learn how to trade xyz because of the natural suspicion – if you can make me rich then why the hell aren’t you in some darkened room making yourself rich, dude? Cut out the middleman. I guess it’s the gonzo version of the active fund charges.

I was Frankie, although I derived the result in a different way from The Escape Artist, by observation and hypothetical experimentation. So I took my £800 gains plus the £1000 stake, and stopped doing that, because it was the logical thing to do. MMM has a nice post on get rich with science. It’s harsh, but when you see the statistics tell you that this is more luck than judgement you can either ignore the results or take the insight offered. If I want to make money out of a spread-betting firm, I will buy their shares. I did learn from this, however, and applied the knowledge to my investing. Trading costs you money. So I stopped selling, and made it a priority to sit on my backside and take the dividends.

That, fundamentally, is the trouble with day-trading. In the end you are part of generating the wall of noise – for you to gain, somebody else must lose. This does not necessarily hold with the stock market over the years – because in aggregate returns accrue to capital. But those returns accrue very slowly. To actually get rich from a 5% p.a. real return you need to live frugally and ideally you need to take a multi-generational view. If you have talent and/or cunning, you are much better off leveraging your capital with a business and then selling it.

How do the rich get rich?

Take a look at the top 10 of the  Forbes Rich List There are more Mark Zuckerbergs,  Bill Gates et al than there are Warren Buffets. If you look through the top 10, the sources of wealth are typically from running or selling a business, followed by ancestral wealth of some sort. Four are self-made, and six are inherited wealth. Forbes trumpets this as saying the American Dream is hale and hearty. I’m not quite sure I want to imagine what it looks like when it’s poorly – holders of old money outweighing new in the top 10 shows maybe the rags to riches isn’t quite as easy as it’s made out. But it can be done. Something else of note is: no actors/actresses. No musicians. No sportspeople. None of the ways teenagers hope to get rich. Something else of note is that most of these are no spring chickens – it’s the greybeards who have all the money. And they’re not a pretty bunch, eh, indeed some of them probably can’t have intact mirrors in their homes.

Of those ten, only one  ‘made it on the stock market’. And curiously few in the top 25  ‘made it day-trading’ 😉 Mind you, Sheldon Adelson comes in at #12 from running casinos. There’s nothing wrong with casinos as a way of making money. It’s just that most people go the wrong way about it! Don’t walk through the casino  doors. Own them.


17 thoughts on “The incredible lure of day-trading”

  1. I think the thing that struck me the most when I first started looking at trading was, as you mention;

    “for you to gain, somebody else must lose”

    and I’m not arrogant or self confident enough to believe that I would come out ahead against someone who has been doing this for years and with huge computing power behind them.

    The house always wins. Why gamble in a casino when you can share in their profits instead.


  2. I have to admit, I’m planning of spread betting medium-long-term on a couple of non-reporting status US listed ETFs, with the bet amount fully covered, to avoid paying income tax on any profits and exchange rate fees.

    We shall see how it turns out!


  3. “Half a billion is doable as income” … i think you mean half a *million*?

    i hold shares in IG (and william hill), so i’m following your advice already …

    IG do try to hedge their exposure into the markets (to the extent that their customers bets don’t balance out – 1 customer betting that X will go up, another that X will go down).

    for spread betting on non-reporting ETFs … that’s not necessarily crazy, though you have to consider the extra risks from
    (a) the solvency of the spread-betting firm (i would mention that IG is the biggest, and i think the strongest financially, but i am biased …);
    (b) being shaken out of your position by a temporary price spike (not quite sure how this works, but presumably you avoid this by keeping the full cash to cover your bet with the spreadbetting firm throughout).
    might it be simpler to buy the ETFs inside an ISA/SIPP?

    if the “american dream” is supposed to be a falsifiable claim (rather than just a vague feeling), presumably it’s the claim that there’s a large degree of class/wealth mobility in the USA. it is bizarre to claim that great inequality of wealth is evidence of wealth mobility. mobility and inequality can both be measured. and there is evidence that lesser inequality promotes mobility. for instance, sweden has less inequality and more mobility than the USA. in practice, the “american dream” is not usually made as a falsibiable claim, but as a way to discourage complaints about extreme inequality (forbes can say directly that ppl shouldn’t complain about a few ppl being very rich – but they wouldn’t even mention the other side of the coin, how many americans are poor).


  4. Thanks for the comment GGS. I’ve looked into this in detail. I tried to buy the ETF in my ISA first, but one isn’t allowed foreign listed ETFs in an ISA. I’ve watched the particular one I was going to buy triple in value since then… 😦

    Going via spread betting also takes currency risk out of the equation. I think that as long as the interest rate stays low, it will be a good proposition.

    I listened to an interesting piece on More or Less, confirming that the UK would be the second poorest state of the US, ahead of only Mississippi. That’s before taking into account how cheap stuff is out there (and also excluding healthcare so it’s not all one way). As for the American dream? I recall the best place to do that is Germany…


  5. @ERG – I guess I wasn’t so circumspect 🙂 I did have a little talent which worked over the couple of weeks to few months, but the backtesting showed I would be slaughtered by what seemed to me black swans. So it was time to get off the hamster wheel. Monevator has an interesting post on the principles behind how the odds slaughter most punters even if they appear a bit favourable. I didn’t derive this mathematically but IG’s backtest simulator showed it well enough.

    @Greg that, I believe is the correct way to use spreadbetting – as was my initial reason for getting an IG account, shorting The Firm’s sharesave.

    I found it hard to qualify their costs one they moved from long dated quarterly period bets to DFB. I will have a similar application to yours soon, when i get hold of my AVC lump sum which is way over the ISA limitation, but I’d like to enter the market over a couple of years (though if it goes all titsup then I may change that to a year 🙂 ) From a tax POV a fully funded longterm spreadbetting holding looks like a huge ISA allowance with what I believe are high platform fees. At least while interest rates are low, keeping the opportunity cost down.

    @great grey gym sock Probably a fair cop in that the Monaco pad is probably affordable to some from income. I was using the value of a billion that I learned at school, 10^9. For the sake of argument, if we take a butcher’s hook at this FTSE100 pay list which is a couple of years old, the half-billion mark is 5* the highest paid. So I reckon we’ll get there next year 🙂 On affordability, let us select Diamond Geezer Bob rocking in at £18M p.a. According to the ONS the ratio of wealth to gross income for the UK as a whole is ~ 7 times. This is notably higher in my case using the high-water-mark of my gross income, and excluding physical assets like land and housing. It’s not unreasonable to assume Diamond Geezer Bob’s ratio is higher, because a) he is better with money and b) he earns a lot more so the cost of living is a lower proportion of his pay, there’s only so much caviar a fellow can eat.

    I don’t find it terribly outlandish to assume a FTSE 100 CEO could be worth £500,000,000, in which case he’s good for a pad at the Odeon development in Monaco and some, ahem, modest living expenses.

    Thanks for confirming IG do hedge long term stuff, I guess that makes sense for instance with my short on The Firm which I held for getting on for a year, and indeed Greg’s plans. It somehow makes me feel better about using them long term, I don’t know why.

    @Greg Tim Worstall goes further and Chris Dillow seems to agree. Update – I didn’t realise Chris Dillow featured on the programme


  6. Spread betting, I tried it, struck lucky first time – made c15% in one morning, and then have given chunks of that back.

    It is a completely different mindset to investing long, you need to be right and at the right time. In the meantime the gearing can be eye-watering.

    I’ve worked out it’s not for me, except to hedge. I just can’t buy into me being that right/lucky!

    The other thing that amazed and scared me was the fact it pays for them to get people to call and email me to see if everything is OK (i.e. why aren’t you trading?). The margins must be big.


  7. “grey gym sock”: an internet wag refers to the aforesaid as “J Grimsock”. I think we should all adopt that mode of address.


  8. In late 2007 I experimented with spread betting and in about a month I turned 100 into 1250. Then, you guessed it – I lost the lot in a couple of days.

    My strategy (if you can call it that) was to pick any market that had been down for 3 or 4 sessions and bet on the ‘probability’ that it would go up.

    All was well on £1 / tick but when I thought I was onto something I scaled up to £10 / tick and very quickly lost the lot.

    What annoyed me most was the bizarre without explanation seemingly random ups and downs as the market opened. I am sure the casino was rigging the table as well as having the odds in their favour.

    Yep. The house always wins…


  9. @David, that’s impressive – clearly I was not enough of a high roller to get that sort of VIP treatment!

    @BeatTheSystem gapping at the beginning and end of the day was the thing I found hard to comprehend with IG – it meant the only way to use them properly was to fully fund the position and avoid any stops like the plague. It seemed mroe volatile that the real stock market, though I guess I don’t have realtime microsecond visibility. Fully funding a short isn’t an easy thing to do, even though I did have those shares long, but time-embargoed 😉


  10. One of the (many) mistakes people make about the markets is in thinking that the winners gain money from the losers. That is patently not true.

    The City is made up of many companies who not only trade with clients, but also between each other and they are forever booking profits. Now sometimes, as in the financial crisis, we find that these profits were illusory and all the bonuses that had already been paid quasi fraudulent, but on the whole it is because of the expansion of the money supply and the economy.

    The group of ‘traders’ is generally making money outside of that ring in the general economy rather than off each other.


  11. @hotairmail

    Is not the part due to the expansion of money supply and the economy the roughly 5% real terms p.a. referred in the post? The trouble with trading frequently is the costs of the frequent turn are out of proportion to the small gains from the expansion of the money supply etc. That’s the case where for some to win, they need to be raking profits off the other punters? There’s just not enough fat in the economy for that to work well.

    Had I not shorted The Firm but went long with IG I would have taken out a bit less than £1k and I agree, that would have been from the wider economy. However, I held that position for over a year without racking myself in and out of the bid/offer spread several times a day. That isn’t trading.


  12. A way to increase the return/income from shares is by writing/selling options.

    Also use a small part of your money to play the casino, sorry stock market, with buying options as an investment/trading instrument rather than treating it as a derivative to protect/increase.
    This is best done with LEAP (Long running) options so that you do not have to panic when the market initially turns against you. You will have enough time left for the market to recover and make you a profit.
    If the gamble pays off, only place another “bet” with the initial sum.
    The profit can be invested buying stocks.

    Remember Mike Ashley’s put options on Tesco?

    A private investor/gambler only needs roughly £1800 to take a similar bet.
    You write/sell 1 ATM (at the money) put contract.
    1 put contract represents 1,000 shares.
    One share is approx. £1.80.
    You receive a premium (depends on the time left until expiration and the strike price) and if the share price goes up you can pocket the premium on expiration day and repeat the bet. If you have to take up the shares they cost you £1.80 minus the premium received. And you can write/sell a call option immediately or wait a bit and hope that the stock recovers somewhat and THEN write a call. You pocket the premium and MAY have to sell the shares.


  13. Mr Ermine – that penthouse suite looks horrible. It hasn’t even got a proper garden. Just so as you know, if you make that much money, please can we stay in the current Ermine Towers? I really don’t want to live in that horrible place! 😉


  14. @Hermione I’m too timid to use leverage that much, but I’ll certainly take a look at it as an alternative to SB to lean against holdings I have that are CGT embargoed – I’d really like to sell some of those to diversify myself out of the single stock.

    @Mrs Ermine Maybe as a weekend pad, or would you prefer One Hyde Park or The Shard?

    I still quite fancy the island and a helicopter. I’ve always had a soft spot for Loch an Eilein, wonder if the Rotheimurchus Estate is open to a buyout, although old money usually never sells capital… Fellow mustelids in the form of pine martens there, too!


  15. Right! I’ve taken the plunge and have a spread bet with a total exposure of £92! (£18 margin required but I’ll be ignoring that…)

    Oh and if you’ve got cash knocking around, BACT has taken a dive and is worth keeping an eye on to see if it falls from its premium. (Careful with the infrequent actual NAV updates – the states premium might not be the same as the actual one!)


  16. @Greg interesting times ahoy I see. I need to get my head round some of this. I know one guy on ERE’s forums used spreadbetting instead of the US equivalent of a ISA for a while. Although the day trading side has a bad rap it wouod be interesting to compare the carrying costs for a stock DFB versus the platform fee of holding it on a regular stock platform.


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