The IRS defines day traders to be those who meet the following three characteristics:
- 1) Traders maintain substantial trading activity. (10-20 daily trades should be sufficient.)
- 2) The trader’s trading activity is sustained on a regular and continued basis and
- 3) The trader seeks to profit from short-term stock price fluctuations rather than dividends, capital appreciation and interest.
NASD defines the day trader somewhat differently. Anyone who executes buy and sell transactions on the same margin account on the same day is said to be day trading.
A pattern day trader executes four or more of these round trip transactions within five business days.
Pattern day traders are required to maintain only 25% margin requirements, rather than the 50% maintained by other non-institutional traders.
NASD Rule 2520 requires maintenance of $25,000 in the margin account to take advantage of this exception.
The Anatomy of Day Traders by Juhani Linnainmaa, University of California, Los Angeles states few characteristics of day traders which are as below:
Demographic Characteristics. A typical day trader is a man in his late 30s who lives in the metropolitan area and turns over his portfolio about once a month. Even after ignoring actual day trades, he trades more and hold stocks for a shorter time than investors in a size-matched control group.
Stock Selection. Day traders tend to day-trade in stocks that
- (1) grab their attention (through excess returns during previous trading sessions),
- (2) they already own, or
- (3) they have day-traded before. Market volatility raises and trading losses in the same stock diminish the likelihood of day trading.
Intraday Behavior. Day traders show a high overall level of activity and demand for liquidity at the opening and the close of the trading session. Day traders who are about to realize a loss from a day trade are very likely to take the loss at the very end of the trading session. We show that day traders try to imitate the behavior of other market participants when they execute trades; they buy (sell) after an uptick (downtick) and after a buyer-initiated (seller initiated) trade. They also pay attention to the depth of the book and react to changes in the bid-ask prices. Their decisions on passive or active limit orders depend strongly on the current state of the market and changes in the market.
Performance. The average return from day trades is very high, but returns are not representative of overall performance because of day traders’ reluctance to realize losses. Day traders’ overall level of performance during the 1998-2000 sample period does not differ from the control group before commissions. This suggests that day traders are not trading on superior information.
Careers. Day traders become more confident and more aggressive as they continue to day-trade. They more often sell stocks that do not own and use more leverage in day trading. Trading losses play an important role in determining the fate of a day trader’s career; the likelihood of quitting day trading increases with the extent of the current losses.
Day trading is different than investing in that investors will hold stocks for the long-term (many years) in hopes that their investment will appreciate in value. Day traders, on the other hand, will place many trades throughout the day in order to profit from the short-term gyrations of the stock market. This difference in time-frame between day trading and investing is what makes them distinct.
Day traders, on the other hand, base their decisions on the behavior of the stock itself as opposed to the underlying company.
Numerous market studies have concluded that accurate market timing is not possible, even for professional money managers. Day trading is the ultimate test of market timing in that the trade is opened and closed within the same day. The emergence of the Internet and the availability of almost instantaneous real-time market data have increasing numbers of public investors interested in trading on a short-term or intraday basis. Retail brokerage firms concentrating on this speculative activity frequently claim that a high percentage of their retail public clients are profitable. The purpose of this analysis was to analyze a statistically significant sample of public day trading experiences in order to determine whether public retail customers really have been successful day traders, and to identify and quantify the risks that public investors face as day or short-term traders.
Day trading is particularly risky
Insights from report by Ronald L. Johnson, Investment Consultant states:
- Study shows that 70% of the public traders will not only lose, but will almost certainly lose everything they invest.
- While the study found that three accounts in twenty-six could successfully conduct short-term trading, there was only one successful day trading account.
- A Sharpe Ratio analysis of the only account considered successful in both short-term and day trading showed the trading returns were not commensurate with the risks to which the account was exposed.
- Five of the six accounts, which realized net profits, were no more than marginally profitable and realized a large percentage of their profits from a single trade.