Day Trading by retail traders in the forex & stock markets is quite popular in South Africa.
The pandemic has been a real growth story for new-age brokerages that offer online trading to retail investors. Many young traders have started trading for the first time in their life during the pandemic.
Many brokers in SA have experienced record growth in their numbers because so many young people are interested in trading online. But this has brought many risks along with it.
It is a well-known fact that the majority of the day traders lose, or don’t make returns that are more than the Fixed Deposit interest rates.
We will discuss how day trading works & the risks day traders face in detail and suggest some ways to mitigate them.
What is Day Trading?
Day trading refers to buying and selling financial instruments on the same day before the market closes.
Day traders participate in all financial markets, but in South Africa most of the day traders trade in the forex and stock markets because of the liquidity they offer.
They try to predict if the price of a security will rise or fall and then trade using derivative products such as Contracts for Difference (CFDs), Options and futures to profit from both the rise or fall in prices.
By using derivative products, they use leverage or borrowed funds to increase their capital and improve their potential profits. But this further increases their risk exposure. There are also risks of scam brokers and a day trader risks losing all his capital if he is not careful.
Day Trading is Risky
Day Traders face many risks including this risk of losing all your funds.
#1 Risk of loss of funds
In the case of most instruments, the daily fluctuation of price is not greater than a few points.
For example, when the price of a security appreciates, it does so in very small fractions. Let’s say 1%. This means that a day trader hoping to profit from this little fractional increase has to buy many units to gain a sizable profit.
For example, if the account size is R10,000, then a 1% gain is R100. So, to make more profits, traders need more capital.
Coming up with such funds can be a problem for a typical day trader hence most of the traders borrow money from their brokers to boost their trading positions. This is called leverage.
Leverage is offered on derivative instruments like Contract for Difference (CFD), options and futures so the trader will choose which leveraged instrument he or she wants to trade the market with.
Leverage is the ratio of how much capital a trader has vs. how much the broker will borrow to him.
Leverage is set by the broker, and in South Africa, traders can access leverage as high as 1:1000 and this leverage determines the initial margin deposit which is the deposit the trader has to make before starting a trade while the broker borrows him the rest.
A leverage is inverse to margin meaning a leverage of 1:1000 results in a margin % of 1/1000 = 0.1%
This means a trader offered a 1:1000 leverage only has to deposit 0.1% of the contract size while the broker borrows him the rest.
If the market moves against the trader, his 0.1% deposit becomes insufficient and a margin call is issued to him by the broker. A margin call protects the broker from losing money more than the trader’s deposits.
During a margin call a broker tells the trader to deposit more money into his account or risk having his trading position liquidated and he loses his 0.1% deposit (in this example).
Example 1: Accessing leverage via a CFD instrument
Johnny is a forex trader who thinks that the EUR.USD sell/buy exchange rate of 1.13/1.14 is likely to go up before the end of the day, meaning the Euro is likely to appreciate against the Dollar.
Johnny decides to profit from this anticipated rise by buying 100,000 units of CFD contract so he calls his broker who then offers him a leverage of 1:1000 and a margin of 0.1%
To open his trading position, Johnny needs to deposit an initial margin of just $114 (i.e.0.1% x 100,000 units x 1.14) while the broker lends him the balance.
Unfortunately for him, by the end of the day the EUR/USD sell/buy price drops to 1.11/1.12 which prompts the broker to ask him to deposit more money as his $114 initial margin is no longer sufficient. Johnny cannot afford to raise more money so the broker closes his position and recovers his loaned money leaving Johnny to suffer a loss as seen below.
The difference between initial buying and current selling price is 0.03 ticks i.e. (1.14 – 1.11)
Loss = 100,000 units x 0.03 = $3,000
Johnny invested $114 of his money and lost $3,000. If the broker does not have negative balance protection, then the trader can lose more than his deposits.
#2 Scam Broker risk
A day trader also faces the risk of being scammed by rogue brokers.
Safe Forex Brokers SA in their research found that in fact, there is a very high number of claims by clients in SA related to issues with withdrawals and cases of traders losing money to fake brokers.
There have been stories of widows and other vulnerable members of society being targeted by unlicensed brokers, illegal get rich quick schemes and convinced into opening accounts with them for trading only for their funds to be siphoned out by the scammers.
Every broker operating in South Africa must be licensed by the Financial Sector Conduct Authority (FSCA) or a tier 1 regulatory body and traders should visit the FSCA website and check for a list of authorized FSPs in South Africa to confirm that they are dealing with a legitimate broker.
Day traders should also check the regulatory body’s website for the phone number and email addresses of the brokers and confirm if it is the same with the one used to contact them. This is because some scam brokers can attempt to steal the identity of a legitimate broker and claim to work for them.
#3 Risk of becoming a debtor
Most day traders can find themselves in debt due to the need to meet margin calls, and sometimes due to over trading.
For example, a trader can lose more on a losing trade & make less profit when winning. This could cause the trader to overtrade even if it means borrowing money from the bank or from his friends just so as to cover his losses.
Traders should be disciplined and not invest more than 2% of their capital in one trade. They should also learn to say no to their ego when it urges them to trade over and over again to cover losses.
#4 Health risks
A day trader could spend the whole day looking at computer screens and over time this can take a toll on his health. The eyes begin to develop problems due to strain on the eye muscles.
Sitting down for long hours is also not good as it makes for a sedentary life style which could lead to ailments like diabetes and nerve damage.
#5 Risk of social trading
Many traders pick a stock to invest in out of FOMO which means the fear of missing out. Even the most experienced traders are guilty of this.
A group of people could come together and drive up the price of a stock through relentless media campaigns, advertising and even spreading outright lies about the stock. These kind of stock are called meme stocks
When the lies are sustained for long enough some people begin to believe them and herd mentality kicks in. Everyone rushes to trade those stocks only for the hype to die down and the value of the stock crashes back taking with it the funds of any traders who don’t get out fast enough.
#6 Risk of hidden charges
Since day traders open and close positions several times in a day charges may apply. Some fees are avoidable while some are not. Some of the fees include:
- Currency conversion fees
- Spread
- Inactivity fees
- Withdrawal fees
- Platform fees
(i) Currency conversion fees:
Some brokers in South Africa offer ZAR trading accounts and online withdrawal via South African Banks. This is ideal if you want to avoid fees associated with changing currency.
(ii) Spread:
Spread is the difference between the bids and ask price and this is how the broker makes money. If the spread is too large you profit will be affected.
If you buy 100,000 units of EUR/USD at bid/ask of say 1.1346/1.1348 the spread is 1.1346-1.1348= 0.0002
This means when you buy 100,000 units of EUR/USD the broker makes $20 (i.e. 100,000units x 0.0002)
(iii) Inactivity fees:
Some brokers will charge you for not using your account for some time. You should check with you broker for how much is charged and how long it takes your account to become inactive.
(iv).Withdrawal fees:
Some brokers charge fees when you withdraw money but most don’t charge for deposits. The amount charged depends on your mode of withdrawal.
(v).Platform fees:
Some brokers may charge you a fee for using their online platform. This fee is avoidable so you can check with your broker.
Stick to Long Term Investing
Investing for the long-term should be your most important goal. Predicting market movements in the short term is nearly impossible. And if you are not using proper money management as a trader, then it is most likely that you will lose your money, as do most of the retail traders.
So, you must stick to investing for longer term of few years & create a portfolio of stocks, debt-based instruments like bonds etc. which would reduce your risk & exposure to a single market. And leave trading to professional traders.
If you still want to trade then only trade with a very small percentage of your capital of less than 5%, and know that you can lose it all.
