Etfs Vs Day Trading: Which Investment Strategy Is Better?

Day trading is a strategy that attempts to profit from short-term price fluctuations by opening and closing multiple trade positions within a single day. Exchange-traded funds (ETFs) have become popular instruments for day traders due to their flexibility, liquidity, and diversification benefits. ETFs offer exposure to various assets, including stocks, bonds, commodities, and cash, and can be traded throughout the day, providing greater flexibility than mutual funds.

When considering whether to invest in ETFs or engage in day trading, it is essential to understand the advantages and risks associated with each approach. Day trading carries high risks due to its short-term nature, with 95% of day traders losing money. In contrast, long-term investing in ETFs increases the chances of profit over time. ETFs provide diversification, cost-effectiveness, and straightforward trading, making them attractive for those seeking a more stable investment strategy.

This introduction sets the stage for further exploration of the pros and cons of investing in ETFs versus engaging in day trading, including considerations such as tax implications, transaction costs, and the emotional aspects of trading.

Day trading ETFs: pros and cons

Pros

Day Trading Exchange-Traded Funds (ETFs) offer a unique blend of flexibility, liquidity, and diversity. They are a brilliant mix of liquidity, transparency, and the ability to trade in real-time.

• Intraday liquidity: ETFs offer intraday liquidity, allowing traders to buy and sell shares throughout the trading day. This feature is particularly advantageous for day traders, who need the flexibility to enter and exit positions quickly based on market conditions.
• Cost-effective: ETFs are generally more cost-effective than other investment vehicles. They have lower expense ratios compared to mutual funds, and trading costs are typically lower due to high liquidity and narrow bid-ask spreads.
• Effective hedging options: With a wide range of ETFs available, traders can hedge against market risks by taking positions in specific sectors, commodities, or bonds.
• Availability of leverage: Many ETFs offer leverage, amplifying potential returns. Leveraged ETFs aim to deliver multiples of the performance of the underlying index or asset. For example, a 2x leveraged ETF seeks to provide twice the daily return of the target index.
• Broad sector exposure: ETFs provide broad sector exposure, allowing day traders to diversify their portfolios and reduce risk. By trading sector-specific ETFs, traders can focus on particular industries or market segments without selecting individual stocks.

Cons

• Taxes and fees: Day trading ETFs incur high tax rates on short-term gains, reducing overall profits. If a stock is sold before one year has passed, any increase in value is taxed at the ordinary income tax rate, which is typically higher than long-term capital gains tax rates. Day traders also often pay a commission every time they buy or sell a stock.
• Risk: Day trading is a risky strategy, with 95% of day traders losing money.
• Competition: When placing a market order, day traders trade against a large number of sophisticated institutional investors and high-frequency trading machines.
• Emotional swings: Day traders often experience emotional swings due to the volatility of the market.

In summary, day trading ETFs offer a dynamic and flexible approach to the stock market, but it is a risky strategy that may not be suitable for everyone.

ETFs vs common stocks for day trading

Day trading involves opening and closing trade positions multiple times a day to profit from short-term price fluctuations. While day traders usually close all their positions at the end of the day, they can trade individual stocks or exchange-traded funds (ETFs).

ETFs are a relatively new instrument for day trading compared to stocks, but they offer the diversification of a mutual fund, high liquidity, real-time stock trading, and low transaction costs. Some ETFs may also qualify for tax benefits.

Ideal ETFs for day trading should have high liquidity, low transaction costs, and tight bid-ask spreads. Most ETFs that fit these criteria are based on broader markets, such as popular indexes like the S&P 500 or a total market index. Day traders can also find high liquidity in specialised theme-based ETFs like gold or oil-based ETFs, but these may have higher transaction costs and fees, making them less suitable for day trading.

Leveraged ETFs may offer high exposure, but they usually lack high liquidity and come with high expense ratios.

Some of the best ETFs for day trading include:

• The Vanguard S&P 500 ETF (VOO)
• The iShares Core S&P 500 ETF (IVV) and SPDR S&P 500 ETF Trust (SPY)
• The Vanguard Total Stock Market ETF (VTI)
• The Schwab U.S. Broad Market ETF (SCHB)
• The iShares Treasury Floating Rate Bond ETF (TFLO)
• The iShares 20+ Year Treasury Bond ETF (TLT)
• The Schwab U.S. TIPS ETF (SCHP)

On the other hand, day trading individual stocks allows traders to focus on a few popular stocks. However, this results in a less diversified portfolio, so the movement of any one stock has a larger impact on the trader's financial health.

Day trading also comes with high transaction costs in the form of taxes and fees, such as trading commissions. If a stock is sold before a year has passed, the profit is taxed at the trader's ordinary income tax rate, which is typically higher than the rate for long-term capital gains.

Additionally, the inherent nature of the capital markets makes day trading a challenging proposition. Minute-to-minute stock price movements are largely random and quickly adjust to new information. Day traders also compete with institutional investors and high-frequency trading machines, making it unlikely for individual traders to gain an advantage.

In conclusion, both ETFs and common stocks are viable options for day trading, and the choice depends on the trader's preferences and strategies. ETFs offer more diversification and lower transaction costs, while day trading individual stocks allows traders to focus on specific stocks and potentially benefit from larger price movements. However, day trading carries high risks and transaction costs, and most day traders lose money.

Best ETFs for day trading

Day trading involves buying and selling positions quickly, with the aim of making small profits by trading large volumes across multiple trades. Day traders typically close all their positions at the end of the day and do not carry them over to the next.

While day trading is a rare feat, and even rarer on a consistent basis, here are some of the best ETFs for day trading:

The Vanguard S&P 500 ETF (VOO)

VOO has one of the lowest expense ratios (0.03%) and successfully mirrors the performance of the S&P 500 Index, which represents the top 500 companies in the U.S. from diverse sectors.

The iShares Core S&P 500 ETF (IVV) and SPDR S&P 500 ETF Trust (SPY)

IVV and SPY work the same way as VOO, with the only difference being that SPY has a slightly higher expense ratio of 0.0945%, and IVV has the same expense ratio as VOO. SPY also offers much higher levels of liquidity, with an average daily trading volume of 98.3 million shares.

The Vanguard Total Stock Market ETF (VTI)

VTI allows traders to bet on a larger total market, covering a broader spectrum of stocks across different market caps. It has an expense ratio of 0.03% and an average daily trading volume of 4.1 million shares.

The Schwab U.S. Broad Market ETF (SCHB)

SCHB is another broad-level market-based ETF that tracks the Dow Jones U.S. Broad Stock Market Index, which includes the top 2,500 largest publicly traded companies in the U.S. It has an average daily trading volume of 2.04 million shares and a low expense ratio of 0.03%.

The iShares Treasury Floating Rate Bond ETF (TFLO)

TFLO is a good and cost-effective option for day traders interested in a bond ETF. This fund attempts to replicate the performance of the Bloomberg U.S. Treasury Floating Rate Index, with a low expense ratio of 0.15%.

The iShares 20+ Year Treasury Bond ETF (TLT)

TLT is another bond-based ETF that provides exposure to long-term U.S. Treasury securities. It offers high liquidity, with 22.1 million shares exchanging hands on average, but has a comparatively higher expense ratio of 0.15%.

The Schwab U.S. TIPS ETF (SCHP)

SCHP is ideal for day traders worried about inflation or looking to benefit from trading on inflation-protected securities. It tracks the performance of the Bloomberg U.S. Treasury Inflation-Linked Securities (Series-L) Bond Index, with a low expense ratio of 0.04%.

IShares Bitcoin ETF ETF (IBIT)

IBIT has a daily average volume of 56 million and an average daily movement of 3.29%. This ETF tracks the price movements of spot Bitcoin by owning/holding Bitcoin.

IShares China Large-Cap ETF (FXI)

FXI has a daily average volume of 49 million and an average daily movement of 1.25%. This ETF tracks the largest 50 companies in China.

IShares 20+ Year Treasury Bond ETF (TLT)

TLT has a daily average volume of 44 million and an average daily movement of 1.02%. This ETF tracks U.S. treasury bonds with 20 years or more to maturity.

SPDR S&P 500 ETF Trust (SPY)

SPY has a daily average volume of 44 million and an average daily movement of 0.82%. This ETF tracks the S&P 500 index, making it quite stable compared to individual stocks, and is widely used by both day traders and investors.

Financial Select Sector SPDR Fund (XLF)

XLF has a daily average volume of 42 million and an average daily movement of 1.05%. This ETF tracks a wide range of stocks in the financial sector.

Defiance Daily Target 2x Short MSTR ETF (SMST)

SMST has a daily average volume of 10 million and an average daily movement of 22.25%. This ETF moves in the opposite direction, twice as much, as MSTR stock on a daily basis.

GraniteShares Trust 2x Long COIN Daily ETF (CONL)

CONL has a daily average volume of 13 million and an average daily movement of 15.35%. This ETF moves twice as much as Coinbase stock on a daily basis.

Direxsion Daily TSLA Bull 2x Shares ETF (TSLL)

TSLL has a daily average volume of 81 million and an average daily movement of 8.91%. This ETF moves twice as much as Tesla stock on a daily basis.

Volatility Shares Trust 2x Ether ETF (ETHU)

ETHU has a daily average volume of 12 million and an average daily movement of 7.11%. This ETF moves twice as much as Ether on a daily basis.

Volatility Shares Trust 2x Bitcoin Strategy ETF (BITX)

BITX has a daily average volume of 12 million and an average daily movement of 6.48%. This ETF moves two times as much as Bitcoin on a daily basis.

Day trading: long-term gains vs short-term gains

Day trading is a strategy that attempts to profit from short-term price fluctuations by opening and closing multiple trade positions within a single day. While it can be profitable, it is a risky endeavour, with an estimated 95% of day traders losing money.

One of the key disadvantages of day trading is the higher tax rates incurred on short-term capital gains. In the US, short-term capital gains are taxed as ordinary income, which can be as high as 37% for the highest earners. In contrast, long-term capital gains (assets held for more than a year) are taxed at a lower rate, typically ranging from 0% to 20%.

For example, suppose an individual earns $100,000 from day trading activities, resulting in short-term capital gains. This income will likely be taxed at the highest rate of 37%, resulting in a tax liability of $37,000. Additionally, short-term capital gains may be subject to a Net Investment Income Tax (NIIT) surtax of up to 3.8%.

On the other hand, if the same individual held their investments for more than a year, they could benefit from the lower long-term capital gains tax rates. Assuming they fall into the 15% tax bracket, they would pay just $15,000 in taxes on their $100,000 profit, resulting in a net gain of $85,000.

Furthermore, day trading often involves higher transaction costs, such as trading commissions and fees, which can eat into potential profits. It is also a time-consuming activity that requires constant monitoring and quick decision-making.

In contrast, long-term investing, such as buying and holding ETFs, offers a more stable and less emotionally taxing approach. ETFs provide diversification, low transaction costs, and tax benefits, making them more suitable for those seeking consistent, long-term returns with less risk and lower taxes.

While day trading can lead to large profits, it is crucial to consider the higher taxes, transaction costs, and inherent risks associated with short-term gains. For most investors, a long-term investment strategy with a diversified portfolio of ETFs is more likely to result in consistent and taxable gains over time.

Day trading: high risk, high reward?

Day trading is a form of trading in which positions are opened and closed within a single day. Day traders aim to profit from short-term price fluctuations and typically close all their positions by the end of the day. While day trading can offer the potential for high rewards, it also carries significant risks and may not be suitable for everyone.

High Risk, High Reward?

Day trading is often associated with high risk due to the short-term nature of the trades. Here are some key considerations regarding the risks and rewards of day trading:

• Volatility: Day trading relies on short-term price movements, which can be highly volatile and unpredictable. While volatility can provide opportunities for profits, it also increases the risk of losses.
• Transaction Costs: Day trading typically involves frequent trading, which leads to higher transaction costs, including taxes and trading commissions. These costs can eat into potential profits and exacerbate losses.
• Competition: Day traders often compete with institutional investors and high-frequency trading machines, which have more resources and information. This puts individual day traders at a potential disadvantage.
• Emotional Factor: Day trading can be emotionally challenging due to the fast-paced and unpredictable nature of the market. Traders may experience stress, anxiety, and emotional swings, which can impact their decision-making.
• Time Commitment: Day trading requires a significant time commitment, as traders need to monitor the market closely throughout the day to identify opportunities and manage their positions.
• Profit Potential: Day trading offers the potential for high rewards if traders can successfully capitalise on short-term price movements. However, it requires skill, knowledge, and a significant amount of luck.

ETFs for Day Trading

Exchange-Traded Funds (ETFs) have become popular among day traders due to their unique characteristics:

• Flexibility: ETFs offer intraday liquidity, allowing traders to buy and sell throughout the trading day. This flexibility enables traders to act quickly based on market conditions.
• Diversification: ETFs provide exposure to a basket of assets, such as stocks, bonds, or commodities, offering diversification and risk mitigation.
• Cost-Effectiveness: ETFs generally have lower expense ratios and trading costs compared to other investment vehicles, making them more cost-effective for frequent trading.
• Transparency: ETFs mirror the performance of specific indices or sectors, providing transparency and allowing traders to track their investments closely.
• Liquidity: Many ETFs have high liquidity, enabling easy execution of trades at fair prices.

Some popular ETFs for day trading include:

• The Vanguard S&P 500 ETF (VOO): Tracks the S&P 500 index, offering diversification and high liquidity.
• The Schwab U.S. Broad Market ETF (SCHB): Tracks the Dow Jones U.S. Broad Stock Market Index, providing exposure to a broad range of stocks.
• The Vanguard Total Stock Market ETF (VTI): Provides exposure to the entire U.S. stock market, including large, mid, small, and micro-cap stocks.
• The iShares Core S&P 500 ETF (IVV) and SPDR S&P 500 ETF Trust (SPY): Both ETFs offer high liquidity and low expense ratios, making them suitable for short-term trading strategies.
• The iShares 20+ Year Treasury Bond ETF (TLT): Focuses on long-term U.S. Treasury bonds, making it popular for trading interest rate trends and economic cycles.
• The iShares Treasury Floating Rate Bond ETF (TFLO): Invests in U.S. Treasury floating-rate bonds, providing exposure to changes in interest rates with low volatility.

Day trading can be a high-risk, high-reward endeavour. While it offers the potential for significant profits, it also carries a high risk of losses. ETFs can be a useful tool for day traders due to their flexibility, diversification, and cost-effectiveness. However, day trading may not be suitable for everyone, and it is essential to carefully consider the risks and rewards before engaging in this trading strategy.

Frequently asked questions