The 4 Reasons Day Trading Can Become Gambling
Is Day Trading gambling? That’s an interesting question, and one that many finance professors would answer with a resound “Yes”.
But it’s not that simple.
Day Trading can be gambling, IF you don’t know what you’re doing… and the reality is that most people don’t know what they are doing.
1 – If You’re in it To Get Rich Quick
The line between Day Trading and gambling gets really thin, really quickly when your expectation is to double your money every day. The reality is that trading (whether it be Day Trading, Swing Trading, or Position Trading) is a business.
A business implies that there is a systematic way of doing things.
Gambling implies that there is no system.
Now I’m not necessarily saying you should approach trading one way or the other. I’m not saying you should be an algorithmic quant, or a discretionary trader. I’m saying find your own trading style, and create a process around that.
Personally, I lean more towards the discretionary style of trading. That’s what suits my personality best. However, I have systems in place, and principles that I follow for when certain events take place.
Speaking of principles, check out Principles, by Ray Dalio for a great read by a legend.
When you treat trading, in any form, like a business, your probability of success vastly improves. Treating trading like a business allows you to systematically track your progress, rather than just throwing money around.
2 – If You’re Using Excessive Leverage
This next reason plays in nicely from the last reason. Using excessive leverage is never a good thing. Don’t get me wrong. I love leverage. It’s great for taking a small account, and turning it into a larger one much faster.
“Hang on a second– Leverage is risky!!”
Yes, I’m not denying that at all. Think of it this way… If you invest in the Stock Market, you will eventually become a millionaire. Heck, you’ll eventually become a billionaire!
I can’t promise you will be alive, but due to the 8th Wonder of the World (Compound Interest) your investment will eventually be worth billions. It will just be a couple of centuries, depending upon your initial investment size.
Okay, jokes aside, do you get my point? Leverage is a good thing… within reason.
That said, there is a time and a place for varying levels of leverage, but too much of a good thing is rarely ever actually good. Using too much leverage repeals your title as “Quick Thinking Trader” or “Savvy Investor”, and replaces it with “Walking Disaster Waiting To Happen”.
Keep your leverage below 10x as a general guideline. This will allow the volatility of your preferred Stock, Future, or Currency to have less of an impact than trading at 20x, or (you better not) 50x.
People seem to forget that the volatility of what your trading correlates to your gains, or losses.
- Let’s say you’re trading the /NQ Futures
- The /NQ Futures are trading at 6000 points (for example)
- The $20 tick value, and 6000 point value gives the /NQ a notional value of $120,000
- If you’re trading the /NQ with $500 in margin per contract that’s 240x in leverage
- Every 1% move in the /NQ futures is a 240% move in your account
Your Risk of Ruin is extremely high. In fact if your fictional account hadn’t blown up by the end of that scenario it should have blown up by the end of this sentence.
That’s just the math and the statistics of it.
If you’re an active trader already, hopefully that last bit of information opened your eyes a bit.
3 – If You’re Too Emotional About It
These reasons flow into each other nicely, because this too plays on the last reason. Being too emotional about trading takes the business aspect out of it, and puts your account right in the hands of the Dealer at the Blackjack table. I probably don’t have to tell you this, but when people are emotional about things, they tend to make poor decisions.
If you’ve studied anything about the human brain, and human decision-making, you understand we have a Fight or Flight response when in stressful situations.
The swell of Adrenaline, and rush of Cortisol from this natural survival mechanism that has been ingrained into our DNA over years, and years of evolution shuts off our ability to make informed, higher level decisions. Your body is in survival mode. Literally, all you’re subconsciously “thinking” about is quite literally fighting or fleeing.
So how do we tame the beast inside of us? How do we not succumb to human nature in the context of emotions and trading? Keep your position size small relative to the Notional Size of what you’re trading, and your account.
In other words, don’t over leverage yourself.
Keep in mind the last example of the /NQ Futures. If you’re trading a $120,000 instrument with $500 in margin, your emotions are going to be all over the place, and you will make terrible decisions.
“Well what if I have a small account? How do I build that up fast, without over-leveraging myself?”
One way is with Options. Options and Options Spreads allow you to limit your risk, while taking advantage of the leverage that they provide.
That’s one way.
4 – If You Think You “Know” Something
This is perhaps the most dangerous reason of all them all, and rapidly shifts the game of Day Trading into gambling.
Thinking you know something, or that you’re smarter than the market will get you killed, figuratively…
You’re really gambling with your money now, if this is your mindset. Mr. Market knows all, and Mr. Market isn’t afraid to dish-out a slice of humble-pie to anyone at any time, for whatever reason.
Even the best Traders and Investors in the world will more often than not tell you that they have no certainty in their decisions. They will tell you that they don’t know anything, and that it’s for the market to decide what goes up and what goes down.
Often times, hearing “I don’t know” is a better and more intelligent sign than “I have absolute certainty about… ” when it comes to talking about the market.
I mentioned Ray Dalio earlier, and while he’s not a Day Trader per se, he often asks the question, “How do I know I’m right?”.
Do you see the distinction there?
Eat the humble-pie, before Mr. Market makes you eat it.
Admit that you don’t know anything. The talking heads on television don’t know anything. Nobody knows anything.
What you can do, what you can know, is your risk.
You can know your downside. You can know how to control your risk. Your risk is all you can control, and truly know.