One time when I was sitting in my college dormitory, I heard a whoop of joy from down the hall. My dormmate announced that he had just made $500,000 trading in the stock market, after having invested only a few thousand dollars. When I asked him how he did it, he grinned and simply said: “Call options.” I spent the rest of the day reading about how this marvelous financial instrument could be used to make a fortune in a day with just a small initial stake.
Of course, my lucky dormmate doubled down on his investment and ended up losing most of his money when the dot-com bubble burst a couple of months later.
This saga illustrates the danger of day trading, especially with leveraged instruments such as options. After the 2000 tech bust, day trading declined, but the coronavirus pandemic seems to be driving something of a renaissance. Goldman Sachs Investment Research reports that the percent of trading volume in the stock and option markets from small trades has increased a lot since January, while discount brokerage TD Ameritrade reports that visits to its website teaching people how to trade stocks have nearly quadrupled. Robinhood, a trading app that offers zero-commission trades and a simple, video-game-style interface, had 3 million new accounts opened in the first quarter. Half of its new customers are first-time investors. Many online communities are filled with the standard elements of day-trader culture — stories of fabulous fortunes gained, hot tips, trading systems and theories and so on.
Coronavirus probably isn’t the only reason for the boom in day trading. Brokers realized that they could offer zero-commission trades and make up for it with interest earned by lending out their cash balances. Mobile apps made trading easier and more fun than ever, and allowed new traders to start off with small amounts of cash. A new generation of speculators has no painful memory of the dot-com bust.
But whatever the reasons, the new day trading mania is not likely to result in a happier outcome than the last one. There are many theoretical reasons and a wealth of empirical evidence to suggest that most day traders are wasting their money.