Day-Traders Beware

Day-trading does involve buying and selling stocks — but it's not investing.

Investors (at least good, Foolish ones) study businesses, carefully select stocks, and often aim to hold on for years. They consider themselves part owners of real businesses. Day-traders, meanwhile, spend hours glued to monitors, watching stock price graphs and placing orders. They'll typically place scores of orders each day and hold each stock for a few minutes or hours. Many ignore company fundamentals, focusing only on what might make the stock move in the very short term. While investors may aim to pay long-term capital gains rates by holding stocks for more than a year, day-traders are stuck paying at the generally higher short-term rate.

A study by the North American Securities Administrators Association suggested that only about 11.5 percent of day-traders might trade profitably and that some 70 percent "will almost certainly lose everything they invest." (Note that trading "profitably" does not even mean one will beat the S&P 500, available via the purchase of an index fund at very low cost.)

According to managers of day-trading firms cited in a Washington Post Magazine article, about 90 percent of day-traders "are washed up within three months." A principal of a day-trading firm even admitted that "95 percent will fail in the first two years." Former Securities and Exchange Commission (SEC) Chairman Arthur Levitt recommended that people only day-trade with "money they can afford to lose." The SEC has called it "highly risky" and warns of possible "devastating losses."

Those who have made the biggest killings in day-trading may be the ones who run daytrading firms, providing day-traders with trading equipment and charging commissions per trade.

People who trade stocks online, though, are not necessarily day-traders. Accessing brokerages online makes sense for most people, especially when commissions for trades can be $5 or less per trade. (Learn more at www.broker.fool.com.)

Resist any temptation to buy and sell stocks rapidly in large numbers. Don't let yourself or those you care about get sucked into day-trading. Learn more about it at www.sec.gov/answers/daytrading.htm.