Wednesday, 23 March 2016

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It has been documented that on average, individual investors lose money from trading stocks. The majority of losses can be traced to trading expenses. However, those costs do not tell the entire story. Individual investors tend to buy stocks that underperform and sell stocks that outperform the market averages.
A 2011 study looked at day-trader's profits and losses over a 15-year period and included something special: It traced the performance of the best and worst traders over a number of years, trying to discover whether successful trading is a "skill" or a random event. The conclusions: "The top-ranked day traders go on to earn money (after expenses) in the following years and the bottom-ranked day traders continue to lose money... Investor skill is an important feature in financial markets...The results of our analysis suggests that less than 1% of day traders are able to outperform consistently. Trading skill is rare."
He concludes that: "Thinking that you can be in the elite group of performers without substantial deliberate practice and experience is stupid. I know of several day traders who have enjoyed very long careers of consistent success. Every one spends significant screen time absorbing market patterns and working on their craft.
If you accept the evidence that short-term trading requires skills that are not easy to acquire, it becomes logical to ask:
Is there any reason to believe that you and I can do better with options?
I hope the bottom line is clear: A short-term trader in any market must have the ability to consistently predict market direction. Whether your holding period is 5 minutes, 5 hours, or five days, a short-term trader cannot afford to pay commissions unless he/she is accurate enough to come out with some cash -- after expenses are deducted. This remains an elusive skill for the vast majority.
Trading options does not help traders for one very important reason: The bid/ask markets are much wider with options than with stocks. A short-term stock trader can buy a position and sell it for a gain of a few pennies per share. But options are different. If you buy a high-delta, in-the-money call option (and that is the type of option that speculators should buy, in my opinion), the bid ask spread may be forty cents to one dollar wide. Thus, when you buy the option (at a price near the asking price) there is no chance to quickly sell it at a profit when the stock price rallies by those same few pennies. It would take a far larger change in the stock price. Why? Because no one will be willing to pay much above the bid price for your option. When the bid and ask prices are not near each other, any you buy near the ask price, there is no possibility of scalping (buying and selling for a quick profit) with options.
The same is true for spreads. To be able to complete a trade (buy and sell), the option trader must overcome the large price differential in the bid/ask prices. That money-losing phenomenon is known as slippage.
My conclusion: It is far more difficult to make money as a day trader when using options than it is with stocks. 
Don't give up on options 
There is no reason why anyone has to become a day trader. Option strategies can be adopted by traders who have longer time horizons -- perhaps a few weeks to six months. Such strategies include.

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