The tax that converts +0.5R expectancy into +0.2R.
Active short-term trading is taxed at ordinary income rates, not the lower long-term capital gains rates. The after-tax expectancy of a high-frequency strategy is materially worse than the headline pre-tax figure suggests.
Short-term vs. long-term capital gains
Most jurisdictions tax short-term gains (held less than a year, or whatever the local cutoff is) at full income-tax rates and long-term gains at a preferred lower rate. The gap can be enormous:
| Jurisdiction | Short-term gain rate | Long-term gain rate | Threshold |
|---|---|---|---|
| US (federal) | 10–37% | 0%, 15%, 20% | 1 year |
| UK | 10–20% (CGT) | 10–20% (CGT) | No distinction |
| Ireland | 33% CGT | 33% CGT | No distinction |
| Hong Kong | 0% | 0% | No CGT |
| Singapore | 0% | 0% | No CGT (for individuals) |
| Germany | 25% Abgeltungsteuer | 25% | No distinction; one-year rule abolished 2009 |
| Australia | marginal | 50% discount × marginal | 1 year |
The US distinction is the most consequential: a top-bracket day trader pays 37 % on every realised gain, vs. 20 % if they had held for ≥1 year. Active trading therefore needs roughly 27 % higher pre-tax returns to match buy-and-hold after tax.
The wash-sale rule (US)
The IRS wash-sale rule disallows a loss for tax purposes if you buy “substantially identical” securities within 30 days before or after the sale at a loss. The disallowed loss is added to the cost basis of the replacement position. For active traders this can mean closing the calendar year with a large realised loss for tax purposes that does not actually offset realised gains — you owe tax on gross gains while the matched losses are deferred to the next tax year.
Pattern Day Trader (PDT) rule
The US FINRA Pattern Day Trader rule requires accounts that execute four or more day trades within five business days to maintain a minimum equity of $25,000. Below the threshold, day-trading is restricted. The rule does not directly tax trading but does shape what's possible at smaller account sizes.
After-tax expectancy
The expectancy framework on the R:R page reports pre-tax outcomes. After-tax outcomes degrade substantially for short-term US traders:
For a strategy with 50 % win rate, 2:1 R:R, +0.5R pre-tax expectancy, and a 32 % effective short-term tax rate (high-bracket federal + state):
- Pre-tax expectancy: +0.5R per trade.
- After-tax (gains taxed, losses deductible): +0.5R × (1 − 0.32) = +0.34R.
- If state has no SALT cap or wash-sale issues impair the loss deduction: +0.5R × 0.68 effective on gains, full 1R loss = +0.16R.
The same strategy held for a year-plus and qualifying for long-term rates (20 % federal + state): +0.5R × 0.75 = +0.375R per trade.
The active short-term version has approximately half the after-tax expectancy of the buy-and-hold equivalent, before considering bid-ask spread and execution costs.
The implication for position sizing
If the strategy's edge is marginal pre-tax, it is probably negative after tax. The position-size discipline preserves capital, but it cannot manufacture edge that doesn't exist. Active short-term traders should:
- Track after-tax results, not gross. Most platforms show gross by default.
- Use tax-advantaged accounts for active strategies where possible (IRA, ISA, SIPP, super depending on jurisdiction).
- Hold winners for the long-term threshold when feasible — the rate differential is often worth the slightly suboptimal exit timing.
- Manage realised losses around year-end with wash-sale awareness.
What the calculator does not address
The position-size calculator computes pre-tax dollar risk. After-tax dollar risk is different (you keep the loss on the way down because losses are deductible) but the calculator does not model this. For after-tax analysis, multiply realised gains by (1 − tax_rate) and realised losses by (1 − tax_rate × deductibility_factor). Most retail traders do not track after-tax results in real time; doing so would change behaviour materially.