Becoming an independent stock trader is easy -- simply open an account at any one of several online discount brokers and begin trading. Surviving as an online trader is another matter. Despite the many tales of easy money found on stock trading blogs, reliable sources conclude that the more actively you trade, the quicker you lose your money.
Trading vs. Investing
In the long run, the stock market gains about 9 percent annually. This doesn't mean you'll make money every year. Markets are volatile, and cycle from bull markets that gain at least 50 percent to bear markets that lose at least 20 percent. Within these large cycles are many smaller ups and downs, often within a single day. While long-term investors seek long-term profits, day traders attempt to profit from short term volatility.
Trading Is Hazardous to Your Wealth
An influential article in "The Journal of Finance" in 2000 provides ample data to show that over a five-year period traders underperformed long-term investors by about a third. The two economists who directed the research boil down the message of their study to a single sentence: Trading is hazardous to your wealth.
O is for Optimism
Over several centuries, European visitors have noted that optimism is a distinguishing American characteristic. We often think our enterprises are going to turn out well, and that positive thinking helps us succeed. But this isn't always true, as Wile E. Coyote demonstrates -- if you run off the edge of a cliff, eventually you'll notice you're in the midst of a disastrous fall. The enthusiasm of beginning stock traders is a case in point. One former trader, Randy Kurtz, notes in retrospect that "taking gonzo risks" just isn't prudent. He now invests in widely diversified index funds that try to come close to the market's average return.
If You're Going to Trade...
While the academic research shows that short-term stock market trading generally doesn't work, you may want to try it anyway. Many online sites, including Option Express, give you the opportunity to open a practice account and begin trading with virtual money. Your practice account keeps track of all your trades and provides a running total of your wins and losses. If you open such an account, no matter what happens, you'll learn a lot about the market and it won't cost you a cent.
Even if you engage in day-trading, you may not qualify as a trader as the IRS defines it. In addition to trading regularly, the IRS requires your activity to be “substantial” and continuous. If you qualify, the IRS allows you to deduct trading losses from your taxable income without limitation. If you do not qualify, the IRS allows you to deduct a maximum of $3,000 in losses annually, although you may carry excess losses forward to succeeding tax years. For qualifying traders, gains and losses from selling
- The New York Times: Seven Tips for Stock Traders Determined to Defy the Odds
- The Journal of Finance: Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors
- The New York Times: The Illogic of Active Trading
- Options Express: Practice Trading Options With a Free $25,000 Virtual Trade Account
- The Power of Positive Thinking, Reverand Norman Vincent Peale
- The New York Times: The Re-education of a Brash Young Stock Picker
I am a retired Registered Investment Advisor with 12 years experience as head of an investment management firm. I also have a Ph.D. in English and have written more than 4,000 articles for regional and national publications.