day traders fools

Q. I've heard a lot about day trading. Is it worth learning more about?


A. Day trading may look like investing, but it's far from it. The market's recent swoon has probably thinned out the ranks of day traders, but just in case you've given the matter some thought, here are some words of warning.


Investors (at least Foolish ones) study businesses, carefully buy stock, and aim to hold on for the long term -- usually years, or even decades. They consider themselves part-owners of real businesses. Day traders, meanwhile, spend most hours that the market is open glued to monitors -- tracking stocks. They'll typically place scores of orders each day and hold each stock for no more than a few hours. Many ignore company fundamentals, focusing only on what might make the stock move in the very short term. While investors aim to pay long-term capital gains rates by holding stocks longer than a year, day traders are stuck paying at the higher short-term rate.


How well do day traders perform? A recent study by the North American Securities Administrators Association suggests that only about 11.5% might trade profitably. (Of course, trading "profitably" does not even mean that they will beat the S&P 500, a performance available at very low cost via the purchase of an index fund.)


According to managers of day-trading firms cited in a Washington Post Magazine article, about 90% of day traders "are washed up within three months." David Shellenberger of the Massachusetts Securities Division has noted that "Most traders will lose all of their money." A principal of a day-trading firm even admitted that "95% [of day traders] will fail in the first two years." Former Securities and Exchange Commission Chairman Arthur Levitt recommends that people only day trade with "money they can afford to lose."


The people who appear to be making the biggest killings in day trading are those running day-trading firms. These outfits provide day traders the use of computer terminals and "tools," and charge customers a commission per trade. With each customer trading all day long, the coffers fill quickly. Regulators are investigating this industry.


Understand that people who trade stocks online are by no means necessarily day traders. Accessing brokerages online makes sense for most people, especially when commissions for online trades can be much lower.


Resist articles you may see here or there profiling a successful day trader. Know that for every success, there are many more failures. Don't let yourself or those you care about get sucked into day trading.


Learn more about day trading in this 1999 PBS collection. And if you don't like our take on day trading, see what the Securities and Exchange Commission has to say about it.


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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.