Do you get a rush from analyzing the market, developing strategies and executing a winning trade? If you’ve enjoyed trading as a hobby during your working years, there’s no reason you can’t keep doing it after you stop working; after all, having fun is one of the keys to being happy during retirement. Here are some tips on how to trade responsibly and avoid the potential downsides of your hobby: anxiety, depression and accidentally demolishing your nest egg.
1. Only Trade With Risk Capital
Only trade with risk capital: capital you can afford to lose without it affecting your daily lifestyle, advises Mike Ser, co-founder of Ser Man Traders and a day trader and coach whose clients include retirees who day trade. Ser believes that with a limited income stream, you should allocate only a small percentage of your total capital to day trading. If you lose it all, close your account. If you succeed, you can afford to take some bigger risks while allocating some of your profits to conservative investments.
“Like I always say to my students, treat day trading like a hobby with systemized risk, and you have a high probability of making money,” says Ser. “If you don’t, you don’t have a much better chance than you would at the casino.”
2. Keep Separate Accounts
One way to make sure you’re only trading with risk capital is to keep that money in a designated day-trading account. “Keep an account for day trading that is separate from the retirement assets that you are using to support your lifestyle,” says Ann C. Logue, CFA, author of “Day Trading for Dummies.” (Wiley, 2014). “That way if you have big losses it won’t affect your day-to-day activities. Of course, if you have profits, you can pull them out for another purpose,” she says.
If you aren’t truly day trading but you’re still following a short-term active-trading strategy, make that separate account a tax-advantaged retirement account and you’ll avoid or postpone paying taxes on your investment gains. You’ll need to learn about the three-day trade settlement rule and other restrictions on trading within retirement accounts. You aren’t allowed short stocks or sell naked calls or puts in an individual retirement account (IRA), for example. In some cases you can get creative and use investment vehicles such as short exchange-traded funds (ETFs) that get around these restrictions, which can vary by broker. Another drawback is that in exchange for not paying taxes on gains, you can’t write off your losses on your tax return. (For more, see How to Choose Stocks for Day Trading.)
3. Budget for Trading
“You can budget for capital additions to your trading account the same way you would budget for travel or hobbies or anything else you like to do,” Logue says. Just view it as you do your other hobbies. “Does your budget allow you to add another $500 or so to your trading account? If so, then do that. If not, then don’t – add less or none at all,” she continues. “Keep in mind that you won’t be able to trade as much with a small account, but that might be OK.”
Robert R. Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pa., advises caution here. He says the problem with hobbies is that they can take over your life, and when you’re not working you have much more time to devote to your hobby. “What was a small and harmless activity can become an obsession,” he says. That can be a problem, he believes, as most people who day trade underperform a buy-and-hold strategy because of transaction costs and behavioral biases. (For more, see Average Rate of Return for Day Traders.)
4. Do Your Research and Evaluate Your Progress
“Don’t day trade without a plan,” says Eric Sajdak, CIO and partner of Fox River Capital, an independent registered investment advisor in Appleton, Wis. “A plan can be as detailed as you want, from a detailed systematic day trading strategy to a simple set of rules that control allocation, but the key is to have a plan,” he says. Set standards for how much you are willing to lose completely: 5% is a popular choice. Control your losses, and if that 5% is wiped out, Sajdak advises that you walk away.
Logue suggests planning and tracking your trades to improve your odds of day trading successfully. Traders should keep a trade diary in which they enter their trades, note why they’re making each trade, what stops they’re using and when they will close it out, according to Logue. “That creates some commitment and forces the trader to think through ahead of time what can happen,” she says. After the trade is closed out, go back to your trade diary and make notes about how it turned out. Your trade diary can be as simple as a notebook, although some traders design spreadsheets, while others use software designed for logging trades. (For more, see Day Trading Strategy Steps and Adjusting Day Trading Strategies for Different Market Conditions.)
5. Don’t Confuse Day Trading with Gambling
Some experts don’t see much difference between day trading and gambling. “Day trading should be looked at as entertainment, much like playing blackjack in Las Vegas,” Johnson says. “And there is nothing wrong with entertainment.” But you have to keep your entertainment costs in check.
Others say day trading and gambling have important fundamental differences. “Mathematically, day trading is a zero-sum game: You’re as likely to make money as lose money,” says Logue. “With gambling you are likely to lose money, as the odds favor the house. An issue is that people who like to gamble – especially those who have a gambling problem – sometimes use day trading as a socially acceptable substitute, and that leads to big losses. If you want a day’s excitement of gambling, go to the casino, where you’ll at least get free drinks.” (For more, see Are You Investing or Gambling? and Going All-In: Comparing Investing and Gambling.)
The Bottom Line
It’s certainly possible to continue your trading hobby during retirement if you approach it sensibly. Create strategies to limit the downside and minimize the fear and anxiety caused by taking risks you can’t afford. Trade in a separate account with a strictly limited and small percentage of your nest egg that you can afford to lose. Make and follow a plan, and keep a trade diary to help you learn from your successes as well as your mistakes. If you take these precautions, you’ll be able to follow Sajdak’s final piece of advice to day-trading retirees: “Have fun, and remember that if you do lose money, it is just a hobby.”