Career trader's perspective on living off trading profits vs living on salary?

[newwurldmn]

I always took the more conservative route and put aside living expenses each year and often think that from a purely economic point of view it simply not worth most people trading full time - invest while working yes.

there are 2 other issues that many forget to take into consideration.
- inflation, you need to grow an account of have some saving unless you expect to constantly trade till you drop.
- taxes - and an example will sum it up - say you start with a 100k and make 1 mil - you pay taxes of 30% - you have 700k .
Lets say you loose 700k ---- you have still actually made 300k - not a bad result but you are back to where you started ----- but with a tax credit.
However, your acct balance is still 0 - you have to make money again but have no base from which to do it.....and it reinforces the issue of being consistent and not just lucky.

I was under the impression you worked for a bank.

The biggest problem with fulltime retail trading is taxes. The "business" is extremely tax inefficient as there are no credits and meaningful deductions one can take.

Compared to long term investing, taxes are again the biggest slippage.
To beat a passive investment you have to do almost double the passive stake every year because the passive stake can earn on the deferred taxes.

 

[butterfacetrader]

How many people are truly full time @home traders that trade only their own capital and are breadwinner of the family? It seems a majority of people who consider themselves traders (not ones working for a firm and trading firm's capital and get a salary or bonus), are probably working while trading to help increase income and net worth a little.

 

[butterfacetrader]

I was under the impression you worked for a bank.

The biggest problem with fulltime retail trading is taxes. The "business" is extremely tax inefficient as there are no credits and meaningful deductions one can take.

Compared to long term investing, taxes are again the biggest slippage.
To beat a passive investment you have to do almost double the passive stake every year because the passive stake can earn on the deferred taxes.

Hard to say. While it may seem 'long term investing' without triggering a realized capital gains can seem to allow gains to be compounded with less frictional losses from taxes, the investment itself can actually fall in value too. While a trader may be able to sell tops and buy back lows for the same security and probably end up on top. Ultimately I don't think there is a clear cut path for which one ends up with a higher net present value in net worth just on the basis of trading frequency alone. Too many variables at play to make this kind of statement on whether long term investing vs trading comes out on top, like how an instrument trades. Most of the time, the argument that long term investing works best for most people, is based on the fact most traders lose money, i.e. buy high sell low. But thats just bad performance of a few. I don't discount some traders being able to come out ahead of just buy and hold investing even factoring taxes. Afterall, gains are not gains until they are realized gains which is why there are some funds that are actively trading rather than just buy and hold. As for dividends collected, everyone (long term investor or short term flippers) get the same tax treatment on the dividends if received.</br ></br > An example: If someone held Citigroup since 1994, he merely breaks even today. He collected 2 decades of dividends, which hardly makes up much. A trader could probably have flipped it a few time and maybe shorted the way down from the tops. The trader may have collected dividends for some holding periods too. Overall, even with taxes factored in, the trader may have made more money on C than the buy and holder. </br ></br > I think there was a research piece somewhere that showed if some trader were able to roughly buy lows and sell tops short term, they would be up more than just buy and hold on the S&P. Of course, nobody can time the market to perfection like that.

 

[stock777]

Taxes are not an issue for the majority of traders here, as paper trading is not reported to the IrS

 

[newwurldmn]

Hard to say. While it may seem 'long term investing' without triggering a realized capital gains can seem to allow gains to be compounded with less frictional losses from taxes, the investment itself can actually fall in value too. While a trader may be able to sell tops and buy back lows for the same security and probably end up on top. Ultimately I don't think there is a clear cut path for which one ends up with a higher net present value in net worth just on the basis of trading frequency alone. Too many variables at play to make this kind of statement on whether long term investing vs trading comes out on top, like how an instrument trades. Most of the time, the argument that long term investing works best for most people, is based on the fact most traders lose money, i.e. buy high sell low. But thats just bad performance of a few. I don't discount some traders being able to come out ahead of just buy and hold investing even factoring taxes. Afterall, gains are not gains until they are realized gains which is why there are some funds that are actively trading rather than just buy and hold. As for dividends collected, everyone (long term investor or short term flippers) get the same tax treatment on the dividends if received.</br ></br > An example: If someone held Citigroup since 1994, he merely breaks even today. He collected 2 decades of dividends, which hardly makes up much. A trader could probably have flipped it a few time and maybe shorted the way down from the tops. The trader may have collected dividends for some holding periods too. Overall, even with taxes factored in, the trader may have made more money on C than the buy and holder. </br ></br > I think there was a research piece somewhere that showed if some trader were able to roughly buy lows and sell tops short term, they would be up more than just buy and hold on the S&P. Of course, nobody can time the market to perfection like that.

You picked possibly the worst stock in the SPX that still in the SPX. What if you did the analysis on the SPX itself (which was easily investible back then): your return would be 9%. Which $1 invested over 20 years and then taxes paid at 20% rate at the end would yield a return of $4.4. To match this you would have to return almost 19%/year before taxes (at a 50% rate).

I'm not saying a trader can't beat a buy and hold, but the hurdles are high:

1. Markets tend to go up. It's very rare they don't. Traders by definition will miss some of this upward drift in hopes of capturing some of the downside volatility. They have to capture enough of the downside volatility to beat the drift.

2. They have to beat the drift by enough to compensate for their extra transaction costs (soft and hard)

3. They have to beat the drift to compensate for the higher tax rates.

If you can do it, you will be extremely wealthy. But it's very difficult and most traders cannot beat these hurdles.

 

[butterfacetrader]

You picked possibly the worst stock in the SPX that still in the SPX. What if you did the analysis on the SPX itself (which was easily investible back then): your return would be 9%. Which $1 invested over 20 years and then taxes paid at 20% rate at the end would yield a return of $4.4. To match this you would have to return almost 19%/year before taxes (at a 50% rate).

I'm not saying a trader can't beat a buy and hold, but the hurdles are high:

1. Markets tend to go up. It's very rare they don't. Traders by definition will miss some of this upward drift in hopes of capturing some of the downside volatility. They have to capture enough of the downside volatility to beat the drift.

2. They have to beat the drift by enough to compensate for their extra transaction costs (soft and hard)

3. They have to beat the drift to compensate for the higher tax rates.

If you can do it, you will be extremely wealthy. But it's very difficult and most traders cannot beat these hurdles.

Yeah but my point is its hard to make a blanket statement about higher frequency of trading being poor compared to buy and hold due to specifically taxes. Thats why that example was chosen because you don't always come out on top by buy and hold alone.

Normally the argument against active trading is most retail traders don't do it well because of inexperience, inability to read market conditions, no edge and their emotions. These are legitimate concerns. But rarely do people attribute taxes as the primary reason against active trading.

OK, lets use the SPX. We were at around SPX1980 a while ago. We get our crystal ball out and say for sure year end it will go to SPX2000. Next year end SPX2100. Buy and holder bought in at SPX1980 a week ago and intends to hold forever. No taxes filed for 2014. No taxes filed for 2015. 2014 paper gain +20, 2015 paper gain +110. Now the trader. Trader shorts SPX1980. Covers here at SPX1920. +60 gain. Goes long SPX1920 and ride till 2000 and sells. +140 for the year total. Lets say he gets taxed 50%. +70 gains. Next year 2015 Q1 tax selling, SPX goes back to 1900. Trader enters long again. lets say he rides it all the way to 2100 and locks profit again. +210, and after tax +105 gain for 2015.

So, the buy and holder has a paper gain total of +130. Trader, after 50% taxes, +175 gain. The point is we can all come up with different scenarios but still the most salient point ultimately is there is no broad stroke about how active trading leads to losses because of taxes alone. I don't see how there is a generalization that traders lose because of taxes. Traders lose because they make bad trades. But someone who locked profits locked profits. The only thing a trader would maybe lose out is for markets making higher lows, and they are unable to buy back in a bull market trend at a lower price than when they sold. Otherwise, they still gain trading, theoretically.

There was a study done that showed traders able to pick the market swings make more than a buy and holder. Theres also a study that showed ITM put selling on the SPX earned more than buy and hold. But all of this is hogwash anyway. In a bull market of course its good. When trends reverse like '08, things arn't as rosie anymore for buy and holders.

 

[MrN]

Trading has nothing to do with buy and hold. The sources of return are not the same. If one feels that they are similar or an "alternative" one should definitely not be trading.

I am fortunate to know a few of the best traders in the world. The thing they have in common is that they want to win as much as possible. Greedy but not necessarily for just for money itself but for winning as much as possible while executing their vision or plan. They live and breath winning not mundane concerns. If one does not have that mentality, I think it is going to be a slog and not worth it.

The markets are too unstable to try to live on 50k profits with a small account. I'd rather try to get a Dunkin Donut's franchise or similar than try that.

 

[newwurldmn]

Yeah but my point is its hard to make a blanket statement about higher frequency of trading being poor compared to buy and hold due to specifically taxes. Thats why that example was chosen because you don't always come out on top by buy and hold alone.

Normally the argument against active trading is most retail traders don't do it well because of inexperience, inability to read market conditions, no edge and their emotions. These are legitimate concerns. But rarely do people attribute taxes as the primary reason against active trading.

OK, lets use the SPX. We were at around SPX1980 a while ago. We get our crystal ball out and say for sure year end it will go to SPX2000. Next year end SPX2100. Buy and holder bought in at SPX1980 a week ago and intends to hold forever. No taxes filed for 2014. No taxes filed for 2015. 2014 paper gain +20, 2015 paper gain +110. Now the trader. Trader shorts SPX1980. Covers here at SPX1920. +60 gain. Goes long SPX1920 and ride till 2000 and sells. +140 for the year total. Lets say he gets taxed 50%. +70 gains. Next year 2015 Q1 tax selling, SPX goes back to 1900. Trader enters long again. lets say he rides it all the way to 2100 and locks profit again. +210, and after tax +105 gain for 2015.

So, the buy and holder has a paper gain total of +130. Trader, after 50% taxes, +175 gain. The point is we can all come up with different scenarios but still the most salient point ultimately is there is no broad stroke about how active trading leads to losses because of taxes alone. I don't see how there is a generalization that traders lose because of taxes. Traders lose because they make bad trades. But someone who locked profits locked profits. The only thing a trader would maybe lose out is for markets making higher lows, and they are unable to buy back in a bull market trend at a lower price than when they sold. Otherwise, they still gain trading, theoretically.

There was a study done that showed traders able to pick the market swings make more than a buy and holder. Theres also a study that showed ITM put selling on the SPX earned more than buy and hold. But all of this is hogwash anyway. In a bull market of course its good. When trends reverse like '08, things arn't as rosie anymore for buy and holders.

I'm not saying traders lose only because of taxes. I'm saying the hurdle rate to be a successful trader is very high. You have 500k in capital. You have two options: you can trade it or buy and hold it. To justify trading it you have to overcome those three issue I described above. It's an opportunity cost calculation.

If you are successful at beating those three, you should be trading actively. If not, you shouldn't be. I don't think most retail traders think about taxes when they think about their trading and its a huge source of slippage.

You cite buywriting as outperforming the market. Your example perfectly highlights what I am saying. The buywriter over the long run outperforms the market by 1% annually. However, he creates 12 taxable events each year. So if the buy and holder does 9%/year, the buy-writer has done 10% but will pay almost 50% in taxes: he will end up with 105% of his principal while the buy and holder will have 109% if he doesn't liquidate. And if he does, the buy-and-holder will still win with 107%. You ignored the tax implications in that strategy. Why? Most research papers do as well.

This is a traders forum. Everything should be determined in the context of opportunity cost; and taxes represent a huge opportunity cost. Yet, it's amazing how many "traders" on here don't do that.

I manage some friends and family money. I am judged on my after-tax returns (approximated) to the S&P500. The argument I made to them was that at the beginning of next year they should have more money to invest in a buy-and-hold strategy than they would if they invested in it today. Next year they can decide if they want to stick with me or switch to a more passive strategy.

 

[butterfacetrader]

I'm not saying traders lose only because of taxes. I'm saying the hurdle rate to be a successful trader is very high. You have 500k in capital. You have two options: you can trade it or buy and hold it. To justify trading it you have to overcome those three issue I described above. It's an opportunity cost calculation.

If you are successful at beating those three, you should be trading actively. If not, you shouldn't be. I don't think most retail traders think about taxes when they think about their trading and its a huge source of slippage.

You cite buywriting as outperforming the market. Your example perfectly highlights what I am saying. The buywriter over the long run outperforms the market by 1% annually. However, he creates 12 taxable events each year. So if the buy and holder does 9%/year, the buy-writer has done 10% but will pay almost 50% in taxes: he will end up with 105% of his principal while the buy and holder will have 109% if he doesn't liquidate. And if he does, the buy-and-holder will still win with 107%. You ignored the tax implications in that strategy. Why? Most research papers do as well.

This is a traders forum. Everything should be determined in the context of opportunity cost; and taxes represent a huge opportunity cost. Yet, it's amazing how many "traders" on here don't do that.

I manage some friends and family money. I am judged on my after-tax returns (approximated) to the S&P500. The argument I made to them was that at the beginning of next year they should have more money to invest in a buy-and-hold strategy than they would if you invested in it today. Next year they can decide if you want to stick with me.

First of all you are way over generalizing here anyway, since not everyone pays the highest tax bracket. Also, a serious trader might trade inside a corporation with deferred taxation by an individual until withdrawn, and only withdraw marginal amounts enough to live on and tax treatment is different yet again than individual taxation on all gains when trading under their own name in nonregistered retail account. So money can continue to maximize market gains. I think most traders consider taxation being a factor but being taxation, there are too many scenarios to make blanket statements.

Volatility presents trading opportunities. In a defined bull market with no volatility, buy and hold wins. In a bull market with lots of volatility trading in channels, trading makes more money provided someone sells short term peaks and buys back at short term bottoms lower than their sell price. Perhaps gains enough to overcome frictional losses of taxes, as I presented in my earlier example.

And like the other guy said, most traders trade because they want to way out beat the market and achieve out sized gains, not something that only beats the market by 1%. Take this year. The S&P is flat to negative now for the year. Pretty much any trader who traded this year with a profit made more than any buy and holder.

But you ultimately agree with my original point. Theres no broad stroking generalization here. You might as well compare S&P buy and holders vs failed traders who are down a lot this year as evidence that buy and hold is the better method. A trader can achieve gains that make it worth while even after taxes. Traders may also value capital preservation and their in and out of positions affords them the ability to choose when to risk capital. Someone who does buy and hold and never looks at it again, might be sitting on losses for a few years. E.g. S&P buy in @ 2007 breakeven was 2013. Citigroup buy in 2006, down +80% in 2014.

Finally, someone who is a career trader as their only breadwinner will need to draw down from cash. Someone sitting on a huge paper gain on non-dividend payers can't pay the bills.

 

[wrbtrader]

...If you are successful at beating those three, you should be trading actively. If not, you shouldn't be. I don't think most retail traders think about taxes when they think about their trading and its a huge source of slippage,,,

+1

Its so true and sad about how many of us retail traders do not treat their trading like a business. Any trader that doesn't think about taxes especially if profitable...its a trader that won't last long.

Worst, tough to get folks to talk about taxes or the business aspects of being a trader. The few times its discussed...only a few replies. In contrast, start a thread about trade signals and the thread goes on forever.