Day trading, in case you’re not familiar, is the practice of buying stocks or ETFs and then selling them the same day. The goal is to do so with the hopes of cashing in at a large profit.
As you might imagine, day traders use a myriad of strategies to try to get the slightest jump on an equity’s movement. These range from trying to anticipate quarterly results to chasing momentum to trading on the day’s news headlines. Experience and familiarity with the trading process can be helpful. But at the end of the day (literally) whether you have gained or lost money is most likely a matter of luck.
Like other get-rich-quick investment strategies the outlier successes of day traders are repeated across the internet. Meanwhile the embarrassing failures go unacknowledged, and the risky practice of trading on-margin—borrowing money to speculate with—gets minimized.
Win or lose, day trading provides an exciting way to speculate with money. And its popularity is growing. According to US News, this is the result of multiple factors, including more people stuck at home during the pandemic, the unavailability of Las Vegas-type betting, and new mobile trading platforms that have made engaging in the practice much easier
Day trading can be as fun as playing the slots. But are the results just as dependent on dumb luck?
According to The Wall Street Journal, there is some evidence that skill may play a role in day trading on a large scale. The example often pointed to is Medallion Fund, a hedge fund managed by James Simons of Renaissance Technologies. For three decades it has consistently outperformed the market by pursuing day trading strategies. However, the fund has clearly taken significantly more risk than simply pursuing a market tracking strategy.
Bradford Cornell, an emeritus finance professor at UCLA who has developed a system for measuring the role of luck in fund management, says that some of Simons’s success cannot be attributed to mere luck. However, his fund’s strategy is one that an individual day trader could not emulate. It involves constantly opening and covering thousands of short-term positions. The fund is reportedly correct on slightly more than half its trades. When this slim margin is carried over millions of transactions, it generates billions of dollars.
The problem is, finding a fund like this in the rearview mirror of history can’t predict what it will do going forward.
By comparison, an individual day trader who also possessed this rare skill might realize a few dollars profit from each session. Not the kind of return that most short-term speculators are looking for.
In his years of studying the role of luck vs. skill in the results of successful fund managers, Professor Cornell has concluded that while these people are undeniably skilled, the statistics show that their rank among the top performers ultimately has much more to do with chance.
He’s convinced it’s even more so for the rest of us.
“For most investors,” he says, “deviations from an index fund are essentially all luck.”
The prudent investor, whose long-term goal is to successfully save for retirement, will rely on a globally diverse portfolio custom-designed by a trusted advisor. If he or she wants excitement, they know they can find it in ways that don’t put their financial future at risk.
