What Is Day Trading? | The Motley Fool (2024)

When people hear the term "day trading," they may think of people trading in and out of stock positions -- and making millions of dollars.

You may have seen advertisem*nts for day trading software, courses, and other products promising that even YOU could quit your job and make a living trading stocks.

Let's set the record straight: Most day traders lose money. It's not because they choose the wrong trading coach, read the wrong books, or buy the wrong programs. It's because, as a day trader, the odds of success are simply not in your favor.

So what is day trading, exactly?

Here's a definition of day trading, some of the reasons day trading is generally a losing battle, and a much less risky path toward potential wealth in the stock market.

What is day trading?

A day trader is someone who regularly buys and sells stock positions during the same trading day, hoping to capture a modest profit on each trade by selling each stock for slightly more than they paid.

This is also known as intraday trading and, if it's done regularly, pattern day trading.

Here's an example: A day trader identifies a pattern in a stock's price and buys 1,000 shares for $20 each. A few minutes later, the stock price moves up to $20.10 per share, and they sell. They profit $0.10 per share, or $100 on the trade. Day traders aim to produce several, or even hundreds, of this type of result each day.

The definition of day trading varies depending on who you ask. Some people consider anyone who buys stocks hoping they go up in value over a relatively short period of time a "day trader." Technically, they're called a "swing trader" -- but the goal is the same.

The key distinction between a day trader (or a swing trader) and long-term investor is the time horizon. Day traders buy securities with the intent of selling quickly at a target price, while long-term investors buy securities with the intent to hold onto them for years and let them slowly gain value.

The problems with day trading

On the surface, day trading may sound fun and exciting. How difficult could it be to buy stocks, wait until they go up by a few cents, sell, and repeat the process? Sounds like a winning plan.

As it turns out, earning profits by day trading is easier said than done.

A lot of complications can keep someone from being a successful day trader, but here are four of the biggest reasons new day traders are unlikely to be profitable.

1. The odds are not in your favor

From the start, day traders are at an inherent disadvantage because of something called bid-ask spreads.

The stock price you see quoted when you look up a stock price is simply the price of the last executed trade. In reality, stock prices are a bit more complex.

What are bid-ask spreads?

The bid is the highest price someone is currently willing to pay for a stock (like an offer from a buyer). The ask is the lowest price someone is willing to sell a stock for (like a seller's listed price), and is generally a few cents higher than the bid price.

The more actively-traded a stock is, the narrower the gap -- but there's still going to be a bit of a spread, no matter how popular the stock is.

An example of bid-ask spreads

Here's an example: Say the current quote for Amazon stock shows a price of $3,505.44. This is the price at which the last executed trade was made.

Then you look deeper and see the current bid price is $3,182.08 and the ask is $3,184.98. This means the lowest amount you can pay for a share of the stock is $2.90 greater than anyone is willing to pay to buy it.

In other words, if you buy Amazon stock as a day trade in this scenario, you'll need the bid price to rise by $2.90 just to break even when you sell. That's before the price goes above your buying price and you can earn a profit. You're effectively starting at a loss the stock needs to overcome before you can make a profit.

This is a simplified example. As a day trader, you can offer a slightly lower price than the ask price, and you can enter an order to sell for a slightly higher price than the bid and have a good chance of buying and selling at those prices.

Still, the general way the market works is that there's a gap that you need to overcome between what buyers are willing to pay and what sellers are willing to accept.

2. You'll pay taxes on the money you make

Let's say you overcome the inherent disadvantages of commissions and bid-ask spreads, and you manage to develop a winning day-trading strategy and earn a profit from day trading stocks.

Now you'll owe taxes on your profits. Day-trading income meets the IRS's definition of a short-term capital gain, so it's taxed like income you earn from employment.

In addition to giving some of your profits to the IRS as taxes, day-trading gains could raise your income enough to push you into a higher tax bracket -- meaning some of your income will be taxed at a higher rate.

3. Emotions can be your worst enemy

Human beings are emotional creatures. And, unfortunately, our emotions are not necessarily wired for successful stock trading.

Here's the problem: When stocks are going up and have lots of momentum behind them, a lot of traders feel compelled to get in on the action and throw money into the market. When things start to turn sour and stocks are falling, the same emotions tell us to get our money out before things get any worse.

It's common knowledge that the point of investing is to buy low and sell high, but our feelings tell us to do the opposite.

4. Technological disadvantages

Certainly lots of day traders who work for big Wall Street firms are consistently successful. So why all the doom and gloom?

It's very different for individual day traders.

One of the problems with day trading from home or at a trading center is the big players on Wall Street have a massive technological advantage over you.

They can react more quickly to market moves on their sophisticated (and expensive) trading platforms. Their algorithmic trading systems are built to detect patterns or irregularities in stock prices far more accurately than humans, or even online brokers, can.

The tools at your disposal simply don't compare with what's available to Wall Street traders.

Think of it like this: Even if you're a phenomenal driver, you wouldn't try to drag race a Ferrari in your minivan.

Most day traders lose money

These realities make day trading about as safe for your money as gambling in a casino. Even if you master your emotions, the odds are definitely against you, and over time your disadvantage gets tougher and tougher to overcome.

Four university professors published a research report in May 2011 in which they analyzed long-term day traders' success rates. They found that in any given year, only about 13% of day traders earn any profit.

Less than 1% of day traders are consistently profitable year after year.

RELATED: The Ascent has curated a list of the best day trading platforms. Check it out!

A less risky way to invest in the stock market

Long-term, buy-and-hold investing is by far a safer way to invest your money in the stock market.

With a solid long-term investing strategy, you aren't going to double your money in a few months, and you probably won't be able to quit your job and live off of your profits anytime soon. But the results of long-term investing can still be impressive.

Consider that the S&P 500 index has historically averaged annual returns of about 10% since its inception in the 1920s. Adjusted for inflation, most experts put average returns around 7%.

If, 30 years ago, you'd invested $5,000 in a basic S&P 500 index fund (a fund that mimics the performance of the overall market), and you added another $5,000 each year, you'd expect to have a nest worth $510,369 today.

Long-term investing certainly isn't guaranteed, either. If you were doing this calculation in 2008 or 2020, your nest egg wouldn't be so attractive. And if you'd bought into the market during the late '90s dot-com bubble when prices were high, you'd have gotten less for your money, and returns would be a little slower.

But, overall, long-term investors tend to grow their money. And they certainly have a greater chance of profitability compared with day traders.

If you're thinking about getting into the stock market, I strongly encourage you to open an account with an online brokerage and adopt a buy-and-hold investment strategy. Leave day trading to the professionals.

RELATED: Want to try a new stock trading platform? Check out The Ascent's moomoo review.