Welcome to a supplementary article to our beginner’s guide to day trading. Day trading is difficult, more much difficult than many online marketers would have you believe. But do day trading strategies work if you put in the time and effort to follow them to the letter?
In this article, I’ll explain why sure-fire day trading strategies can’t be as easy as they seem. I’ll use simple examples and financial markets concepts to make my case.
In a world where day trading is becoming more popular by the week, I think it’s important for honest and impartial information like this article to be seen by day trading newbies considering whether to trade with real money.
The objective of this series is not to discourage all investors from day trading, but to run home the point that day trading is a difficult profession with serious risks, and isn’t a 2 hour per day path to easy riches.
Take a look at day trading investing courses page and investing book recommendations if you’re interested in learning more about the exciting world of financial markets.
Do day trading strategies work?
Why formulae are doomed
Online courses along the ‘get-rich-quick’ lines may describe themselves as a ‘step by step guide’ or a ‘blueprint’ or ‘formula’ to placing profitable trades.
The idea that a specific trade idea will be ‘evergreen’ and always profitable, is a non-starter from the outset.
Most trading ideas are constrained by two factors:
- Limited time opportunity
- Limited liquidity
Limited time opportunity alludes to the fact that given prices fluctuate – an opportunity to buy or sell will only present itself for a short window of time. For a long term value investor, that window might be years long. But for a short-term day trader, that window could be only a matter of seconds.
Limited liquidity means that only a finite amount of capital can chase that trade before the opportunity disappears.
This sounds like magic, but it’s just one of the elegant ways in which financial markets work. When a pricing anomaly appears – the impact of traders acting with a profit-seeking motivation, will begin placing trades that causes the anomaly to ‘self-correct’.
Example of finite liquidity of a step by step day trading strategy
Let’s say for example you find a simple scalping opportunity linked to a FTSE 100 company with a dual listing on the London and New York Stock Exchange:
The price of the shares in London is £10.00, which is £0.50 higher on the LSE than the NYSE @ £9.50 (after converting). Therefore you see an opportunity to sell some LSE shares and buy shares back on the NYSE.
It’s a simple arbitrage trade, with limited liquidity.
This is because when you begin selling the London shares, you will eventually run out of buyers at that price, and you will need to offer a lower price to trade any further.
Over on the US market, you will also quickly exhaust the number of people willing to sell to you at £9.50, therefore you will need to offer a higher value to continue to trade.
As you throw more money at a trade, the pricing on each side becomes less advantageous, until there is no margin to be made at all.
By placing the trades, you have single handedly ‘fixed’ the pricing anomaly, and in doing so, you’ve exhausted further hopes of making a profit.
This example helps me to explain why a formula contained in a mass-marketed investing course cannot reliably produce a profit. As soon as multiple traders see an opportunity, they will continue to allocate capital to that trade until they exhaust it.
Who actually gets to make money on that trade now becomes a race against the clock the next time it opens. This hands the advantage to veteran traders with the assistance of lightning-fast trading algorithms. These groups will often be winners, as they can spot, buy and sell in the blink of an eye.
Summary: Do day trading strategies work?
It can be disappointing to learn that ‘proven’ and ‘tested’ day trading secrets are anything but. This is one of the drawbacks of day trading.
However, the dynamic and ever-changing nature of the financial markets which causes these opportunities to vanish as quickly as they appear, are the same qualities that make investing so exciting.
If day trading strategies did work, then would there be any sense of achievement in actually ‘beating’ the market?