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Day Trading is a Negative Sum Game | Why Most Day Traders Lose Money - YouTube
Channel: Financial Intelligence
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In this video, I want to talk about the fact
that day trading stocks is in reality a negative
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sum game.
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The term negative-sum game describes situations
in which the total of gains and losses is
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less than zero mainly because the party that
facilitates the game charges both players
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for their participation.
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What this means is that since there are costs
associated with day trading, the total amount
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gained by winning day traders is less than
the total amount lost by losing day traders.
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In other words, the day trading community
in aggregate is unprofitable because there
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are many costs that they need to pay in order
to participate in the game.
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"The house always wins" is a popular saying
describing how casino games have an inherent
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bias toward the casino, or "house" (described
as the "house edge").
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In the case of day trading, the house is the
collection of financial institutions and the
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government that makes day trading possible.
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Since they will charge both winners and losers,
they have an inherent edge.
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Gamblers or day traders in this case might
win from time to time, but in the long term
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and in aggregate, they will lose.
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In this video, I want to share with you three
main costs associated with day trading that
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make this activity a negative sum game.
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If you like the type of content that I provide,
consider subscribing to the channel and give
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a thumbs up and hit the notification Bell
so that you won't miss any of my future videos.
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Cost #1: Transaction costs
Now that commission-free trades for stocks
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are the industry standard among top online
brokerages, many people assume that there
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is no transaction cost involved when stocks
change hands.
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Nothing could be further from the truth.
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In reality, there are a lot of players who
are involved in facilitating these transactions
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and all of them make lots of money.
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The real transaction costs are hidden to give
traders the illusion that it is free to buy
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and sell stocks and to entice them to increase
their trading frequency.
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The transition costs are one of the main reasons
why day trading is in fact a negative sum
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game rather than a zero-sum game.
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The transaction costs are hidden from day
traders because they are included in the bid-ask
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spread for the most part.
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As you know, there is always a difference
between the price that you pay for stocks
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when you buy them, in other words the ask
price, and the price that you get for your
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stocks when you sell them, in other words
the bid price.
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For example, if you buy a share of company
XYZ for $100, the person who sold it to you
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will receive only say $99.5 and the financial
institution that facilitates the trade will
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pocket the delta.
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The bid-ask difference is the price that day
traders pay for the transaction.
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Online brokerages that offer commission-free
trades, charge day traders hidden commissions
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through imposing larger bid-ask spreads which
usually go unnoticed.
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Cost #2: Short-term gain taxes
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Day traders who make money during a tax year
are supposed to pay taxes on their gains.
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Since most day traders rarely hold their positions
for longer than a year, their profits are
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taxed at the short-term capital gains tax
rate.
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Short-term capital gains and losses are those
realized from the sale of investments that
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you have owned for 1 year or less.
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Short-term profits are taxed at your maximum
tax rate, just like your salary, up to 37%
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and could even be subject to the additional
3.8% Medicare surtax, depending on your income
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level.
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On the other hand, day traders who lose money
on aggregate from trades done during a tax
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year are allowed to reduce their taxable income
up to $3,000 in non-investment income.
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The reason that I mentioned this limit is
to show you that day traders who make money
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are taxed on the full amount of their gains
with no limit.
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However, day traders who lose money are allowed
to write off only up to $3,000 of those losses.
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Therefore, assuming that the amount of gains
by winning day traders and losses by losing
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day traders are equal, the government also
makes money from day traders.
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That is because the government taxes the winners
at the short-term capital gains tax rate and
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allows the losers to only write off a small
fraction of their losses.
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Cost #3: Miscellaneous costs
There are also miscellaneous costs associated
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with day trading that are paid by both the
winners and the losers.
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The first one is the amount of time invested
in day trading.
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Many hours are dedicated to watching the charts
and analyzing trends.
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Since those hours could be spent on other
activities, there is an opportunity cost associated
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with day trading.
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The second cost category is the amount of
money spent on courses, books, and tools.
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Many traders invest a significant amount of
money on buying courses and tools that are
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supposed to help them become successful day
traders.
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Last but not least, there is a cost associated
with the mental energy invested in day trading.
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Day trading is an activity that can significantly
drain your mental energy and cause excessive
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stress.
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The health cost of engaging in day trading
is something that many day traders overlook.
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In summary, I believe that day trading is
a negative sum game.
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That is not to say that there are not any
successful day traders out there.
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However, I believe that it is a very competitive
game and only a handful of people can become
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successful at it.
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