Why should you get your Financial House in Order first?
Trading and speculation in stocks (more commonly called ‘Day trading’) has been around as long as the stock market has been in existence. Whether it’s the days of the Buttonwood tree on Wall Street, or the Bucket Shops of the 1920’s, or the electronic trading that takes place every day across the Internet, there are and there always will be “traders”.
It’s certainly not difficult to imagine that the first time a person bought a stock and saw it go up, they had the urge to sell and take a quick profit. Day trading is nothing new – it’s simply human nature to want to take a quick profit and then repeat the process.
Some people would like you to believe day trading is something new and that therefore it must somehow be “bad”. However, when you really stop and think about it, day trading is really no more risky than any type of investing or financial speculation. Any investment or trade can go bad, just like any trade or investment can go well. Just talk to anyone that has owned large amounts of real estate for any extended period of time. There have been times in the economy when interest rates skyrocketed and sudden exposure to a large mortgage has been quite risky. No matter what the situation, speculation with any financial instrument brings some amount of risk – especially if done incorrectly or unwisely. Day trading is no different.
Certainly, day trading, like anything else, can be risky if you don’t know what you are doing. I’ve known of people making one silly mistake and getting wiped out overnight. Since day trading does come with a certain amount of risks, it’s only wise to get your financial house in order before you begin. As such, a few basic guidelines are in order.
First, we should understand that there are two basic categories of people that tend to seek out day trading and that these two categories are drastically different in their approaches to the markets.
The first (and more historically typical) category is made up of people who are basically pretty financially well off. These include individuals who have solid financial worth from other means. They also tend to have homes which are paid for (or largely paid for) as well as being relatively high net worth individuals, particularly in the liquid asset category. For individuals in this category, day trading most likely is only a small part of an overall (and diversified) investment strategies or portfolio – and typically it’s only used to further an already solid net worth without exposing a high percentage of the individual’s assets to undo risks. Basically, these are individuals that can “afford” to do a little day trading and typically don’t go overboard in “only” stock speculation.
The second (and not only more recent but more dangerous) category tends to be people who are attempting to build their net worth strictly from day trading. These are individuals who view day trading not so much as simply one small aspect of an overall financial investment landscape, but more as the major way to generate and build their entire financial worth. This tends to also be the category of people who take larger risks and sometimes generate a bit of negative press regarding day trading. This negative press would be along the lines of people that day trade using funds from a credit card and/or home equity mortgage of some form or another. When things don’t go well in the markets, typically the losses tend to have a more dramatic impact on the individual’s net worth and lifestyle.
It’s pretty clear that these are two radically different approaches to day trading. If you are in the first category, then as long as you do not expose more than around 10% to 20% of your overall liquid net worth to stock speculation, you probably won’t get into too much trouble. However, if you fall into the second category – where you are trying to create wealth via day trading and/or you are using day-trading as your only means of addressing stocks – then some guidelines are in order.
Of course, at the end of the day, no one can force you to follow these guidelines. However, if nothing else, you should strongly consider the following information as it relates to your individual case.
First and foremost, you should never trade using the money you cannot honestly afford to lose should some catastrophic event wipe you out in the markets. These funds should be largely similar to funds you would earmark for Vegas or other forms of higher risk speculation. In the event you lost these funds in total, they should not have any dramatic impact on your life whatsoever. Generally speaking, these funds should represent no more than 10% to 20% of your overall liquid net worth. Beyond this, you should strongly take into account areas of your financial picture such as home ownership, outstanding short and long term debts, as well as future responsibilities such as college for your kids, etc.
You should also take into consideration your age as it relates to your future retirement. Day trading at age 20 or 30 is one thing, day trading your retirement funds at age 65 or 70 is a whole different situation and very unwise unless you limit a number of funds at risk.
Again, before you undertake anything but casual day trading, you should seriously consider such things as paying down all of your short-term debt. This would include paying off all credit card balances and any loans which may be near maturity. You should also consider allocating funds for and/or paying off longer term debts such as car notes and/or home mortgages. Additionally, if you have a family to provide for, you should not only consult with your wife, husband, etc. Before attempting any sort of day trading, but you should take into account what impact large and unexpected losses could have on your current as well as future living situation.
Generally speaking, unless you have tremendous earning power, you should have very little debt and a stable housing situation before using much capital in the markets for day trading. Now, start to make your financial house in order.