Trading costs are the problem. When you enter a trade, there are two key elements to the cost. One is the brokerage fee, and the second is slippage (the loss you experience when you are filled at a worse price than you had hoped for – not a factor if you’re trading method enters with limit orders). Whether you target a large or small profit, your trading cost is fixed.
A day trader inevitably targets smaller moves than a longer term trader. Therefore, trading costs are going to consume a greater percentage of the profit. For example, assume you are trading a futures market where your average trading cost is half a point. A day trader aiming at a four point profit for a trade will lose 12.5% in trading costs. A long-term trader targeting a 50 point profit will lose only one percent in trading costs.
When you design day trading systems, you will often find a method appears to yield an excellent return until you factor in the likely trading costs. When you do so, the apparent positive expectancy often turns negative.
Offsetting this disadvantage are three significant advantages:
A day trader tends to be in the market for very short periods of time. (For example, using one of my own favourite methods my average trading time is less than 10 min per day.) This vastly reduces the risk from unexpected events which seriously disrupt the market. Such events happen more often than you may think, and can be very expensive.
As a simple real-life example, the soy beans (November 2010) futures contract touched 1070 during the last hour of trading on 7 October 2010. It would not have been unreasonable to go short at 1070, with, say, a stop loss set at 1075. A day trader would have been well pleased because the price at the close, when the day trader would exit the position, was 1070 – a five point profit on the short trade.
The longer term trader would no doubt be looking forward to the open on the following day (a Friday morning), but prior to the open the government released a surprising report showing that corn supplies were much lower than had been anticipated. This had a flow on effect in the beans market causing it to open limit up at 1135 (normally the price of a beans futures contract is not permitted to move more than 70 points from the previous close in any one trading session). As there were no buyers at 1135, there were no trades that day. Therefore, the stop loss order at 1075 was not triggered.
The long-term trader has gone from an open profit of five points on the Thursday night to an open loss of 65 points on Friday night and faces a long, worrying weekend. On the following Monday, the exchange expanded the limit by 50% permitting moves of up to 105 points. The trader watched the open with trepidation, knowing that it is not uncommon for limit moves to continue for several days… Fortunately, in this case, the market did not open limit up again, but it did rise a long way to 1176.5. As there were trades at this level, the stop loss order would be triggered, crystallising a loss of 106.5 points.
Whether the trader would survive this trade depends on his or her capitalisation and the degree of risk they took when entering the trade. The trader had anticipated a five-point risk in the trade, but eventually experienced a loss more than 21 times as large as this. If that five point risk had represented 5% of available capital, this trade would have been ruinous. If the five-point risk represented 1% of available capital, this trade would have been very unpleasant, but the trader may still have been in the game…
The risk of unexpected events causing market price to gap through stop loss orders is much greater when you are in the market overnight, over weekends and during public holidays. To my mind, the greatest single benefit of being a day trader is that you are largely protected from such events and get to sleep soundly at nights.
The second significant advantage enjoyed by a day trader is that their drawdown periods are much shorter. To explain this, it is important to realise that any trading method will inevitably suffer bad runs. When such runs occur, the peak value of our capital account dips until eventually we begin winning again and the capital account balance moves to a new high point.
With most trading methods, it is not unreasonable to expect that such drawdown periods may span, for example, 20 trades. (This is not to say that all these trades are losers, but simply that during this period there are sufficient losers to prevent us from exceeding the previous high point of our capital account value.)
If we are long-term trader with an average trade length of one month, this implies that we will experience a very lean period for up to 20 months! In contrast, a day trader who aims to trade just once per day, can look forward to working through the drawdown in about one month. This is why day trading is almost mandatory for traders hoping to trade for a living. Very few such traders would have the resources and tenacity to survive a 20 month period without making any money.