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If you have ever been involved with the stock market, you’ve probably heard the term “day trading” before.
Day trading is one of the most popular trading strategies practiced on the stock, options, futures, currency, and crypto markets and involves buying financial instruments and selling them not long after the time of purchase.
While the timeframes for each trade may vary, the principal definition of day trading requires for the bought instruments to be sold before the current session closes, or before the day ends.
Day trading is especially popular among professional traders, who often have access to a large pool of capital so they can pick and choose their trades depending on current market conditions.
While anyone can practice day trading in theory, in practice there are a few hurdles that may bar inexperienced traders from starting day trading.
In some cases, such as stock trading, there are capital requirements to be admitted as a “pattern day-trader”, which usually implies that the trader knows what they are doing and assumes all risk responsibly.
If you are a beginner trader and would like to delve deeper into the world of day trading, this Investfox guide is the one for you.
As someone who is new to day trading, it is important to get a clear picture of what day trading is, how it works, and what benefits and risks are involved in the process.
Day trading refers to an approach to trading that involves buying and selling financial securities within the same day, or often within a matter of seconds/minutes.
Day traders typically focus on smaller margins and higher volumes, which can add up to substantial gains over the long term. However, it must be noted that day trading can be very risky, as the markets are volatile and prices constantly shift.
Day trading has become especially popular ever since the advent of the internet and online trading has taken over the markets.
Due to razor-thin margins and short timeframes, day traders have to rely on a wide variety of technical indicators to anticipate market movements and make profitable trades, which is easier said than done in an especially volatile market.
Institutions often employ a diverse group of day traders and give them specific instructions about what to trade, how to structure their trades and how to size their positions.
In some cases, day traders have complete autonomy over their trading decisions, so long as they meet their performance expectations.
Although day trading is typically not advised for complete beginners in the stock market, you can still learn a lot by familiarizing yourself with the basic concepts of day trading, which can help you better understand the inner workings of the stock market, so you can construct consistently profitable trading strategies on your own.
Before you start day trading, it is crucial to nail down the basics of the stock market - what it is, how it works, and get to grips with why so many people choose to invest in it.
Once you’ve become familiar with these basic concepts, you can start experimenting by opening a brokerage account and using their paper trading account, often called a demo account, which works with simulated funds and does not put your real capital at risk.
In general, it is best to stay away from day trading as a complete beginner, but once you’ve accumulated some experience and knowledge of the markets, setting some of your capital aside to practice day trading could prove to be a highly rewarding experience.
While buying and selling stocks is a fairly straightforward process that is easy to follow, day trading introduces a degree of risk and fast decision making that regular stock trading does not require.
For example, buying AAPL stocks to sell them a couple of months later at a higher price is a very basic and reasonable investment to make.
On the other hand, day trading AAPL stocks involves timing the market perfectly, while dealing with a lot of sudden shifts in price. This is especially true for AAPL stock, as it is extremely liquid and attracts a lot of “smart money” from a wide range of financial institutions who typically trade in very large quantities.
Once you’ve set up your trading account and accumulated some experience, you can switch your strategy to day trading, which is far easier than it may first seem.
Switching from basic stock trading and investing to day trading does not involve any additional registrations or a shift in your account - it simply means that you will be buying and selling stocks at much smaller intervals and will be avoiding holding any stocks going into the next day’s trading session.
As you may already know, the stock market is only open during workdays (assuming there are no stock market holidays). Therefore, you can buy and sell a stock on Monday and sell it on the same day: Congratulations! You are now a day-trader.
However, there is one crucial rule for U.S. day traders that sets them apart from regular stock traders, which is the “pattern day-trader” rule, which we will cover shortly.
As a day-trader, you will have to grapple with an ever-changing stock market, which amplifies the importance of awareness and quick thinking.
When choosing a stock, there are three core components you should never ignore, which are:
As we have previously mentioned, the pattern-day trading rule applies to all day traders and limits the number of participants who can engage in pattern day trading.
Pattern day trading refers to day trading activity that is continuous throughout at least 4 out of the 5 possible stock market days in a week.
For instance, if you day-traded every day except on Fridays, you would be qualified as a pattern day-trader and you would be required to have at least $25,000 in your account to continue day trading. Once the value of your account dips below this threshold, your broker will notify you that you will not be able to continue pattern day trading unless your account is brought back up to $25,000.
This rule is strictly enforced and your broker is obligated to automatically detect pattern day trading activity on your account.
However, it must be noted that day trading on 3 working days out of 5 will result in the pattern day-trader status, as well as the $25,000 restriction on your account to be lifted by your broker.
Day traders do not only rely on their instincts to make profitable trades. There are a wide variety of tools and techniques available to help them make quick decisions that are based on sound technical knowledge and time-tested strategies.
Institutional day traders often have access to state of the art software and complex technical indicators to help them sort through the clutter and identify profitable opportunities as they unfold.
As a beginner day trader, choosing the right brokerage and setting up your stock trading account is the first step to ensuring a comfortable trading experience. Day trading can be a stressful ordeal and nobody wants an inadequate piece of software making things harder for them.
This is why it is essential to choose a time-tested brokerage with high quality software and responsive support so you can easily reach out to them in case of any issues on their end.
Another key consideration is cost. A brokerage with zero trading fees is ideal for day trading. On the other hand, a brokerage with slightly above-average fees can quickly start eating into your profits as you execute multiple trades a day.
Your brokerage account is the primary source of trading software you will be using while trading stocks, therefore, it is in your best interest to pick the one that has a proven track record and a high quality service.
Another key resource you will need as a day-trader is market data. Knowing what is happening on the market is incredibly important, as you cannot track everything all at once, having a brief overview of some key market developments can go a long way.
Data points, such as economic and general policy news can help you anticipate the movements of some larger players. By identifying their preferred investments, you can follow the “smart money” trail and trade stocks with an increased volume - increasing liquidity and your chances of success.
Customizable stock price charts are some of the most useful tools in a day trader’s arsenal. The ability to quickly shift between timeframes and add a host of technical indicators to the chart gives traders the ability to quickly find what they are looking for and decide whether a particular stock is worth trading or not.
While trading software and charting tools are essential for any day-trader, there are also a number of other helpful pieces of software that can assist in different ways.
For example, a financial calendar can help day traders anticipate important events in a company’s schedule, such as an earnings call, which can trigger a buying or selling spree on the stock, increasing volatility and setting the stage for some lucrative day trading.
Stock screeners and trading journals are also very helpful in organizing and recording your trades to learn from past mistakes or to tweak your strategy based on past performances.
Additional educational materials can also be fruitful for beginners to quickly fill in the gaps in their knowledge of the markets.
Complete beginners may find the intricacies of day trading somewhat difficult to follow, which is why it is crucial to have a clear understanding of what to expect from the stock market and how to formulate a strategy that makes sense for your financial objectives.
It goes without saying that no day trader can be successful without a good knowledge of stock market fundamentals. This involves understanding the general concepts regarding stocks, as well as some basic strategies and key dates to look out for.
Here are a few stock market fundamentals everyone interested in day trading should know:
There are two distinct approaches when it comes to analyzing a stock - technical and fundamental.
While these two methods are often used in tandem by most traders, there are core differences between them, as well as the scenarios when they can be used to their full advantage.
It is important to note that neither of the methods of analysis exist in isolation and a combination of the two typically gives traders a much better idea of what is happening on the market.
Developing a day trading strategy can be the hardest part of the job which requires careful balancing and frequent reiterations to achieve the desired results.
While theoretical knowledge of the markets, as well as a good sense of timing your trades, are crucial skills to have, developing your day trading strategy will inevitably include a lot of trial and error and this should not discourage you from trying to hone your skills and improve your strategy one trade at a time.
Once you’ve finally set your sight on a shortlist of stocks you would like to day-trade, it is vital to decide what approach you are willing to take, which depends greatly on your risk tolerance, level of proficiency, and to some extent, the amount of capital at your disposal.
In general, there are a few different styles of day trading you can choose from, such as:
Timing the market can be very difficult for day traders, which is why it is so important to have clear entry and exit strategies when making trades.
There are a few ways you can structure your entries and exits, which depend on your overall trading strategy.
For example, momentum traders may enter when they see a spike in momentum, hoping to ride the wave and exit once the momentum starts to slightly dip. On the other hand, some traders may target breakouts as their point of entry and make trades when the trend is contained within a small range.
Entry and exit strategies are tied to the concept of risk management, which we will discuss further in the next section.
Considering the inherent risks associated with day trading, the importance of proper risk management cannot be understated.
Day traders can use a number of methods to cut their losses when a trade isn’t going in their favor, or to simply limit the potential downside of their existing positions.
While it is true that day traders do not hold open positions for extended periods, this also heightens the risk of costly mistakes and increases the need for safety precautions.
Stop-loss and take-profit orders are some of the most versatile tools at day traders’ disposal. They are integral components of day trading risk management and help traders control potential losses and lock in profits.
Both of these orders seek to contain trades within reasonable bounds to avoid traders spending too long on single positions. They are especially handy for day traders, who wish to move on to the next trade as soon as possible.
Choosing the size and dollar value of your positions can help you stay within your means and not overextend when trading stock with lower liquidity.
The process of managing position sizes can be broken down into the following steps:
If you follow these simple rules, you can avoid the hassle of overextending on a trade and having to prolong an open position in hopes of a rebound.
Beginner traders need a lot of practice to hone their skills. However, doing so with real capital involves a high degree of risk, which is why most brokerages and third parties offer demo trading accounts and simulators where traders have access to the markets with simulated capital to test out their strategies and see what works for them.
Demo accounts are provided by online brokerages and give traders simulated capital (typically $100,000) and allow them to make trades and see where their strategies might need adjustments.
Some demo accounts may impose restrictions on concentration to teach traders about the importance of diversification.
These demo accounts, also known as paper trading accounts, give traders access to the broker’s actual trading platform, which is another great way for traders to warm up and familiarize themselves with the software.
Paper trading accounts are common tools offered free of charge and it is always advisable for beginners to take full advantage of this opportunity to learn before putting real capital at risk.
Different from demo accounts, trading simulators are typically third-party programs that offer a similar service to traders, with some additional perks and features included.
Some simulators are not free and come with a diverse package of auxiliary software, while others are free and concentrated on the basics of order placement and execution.
Most trading simulators have access to real-time market data to make traders feel like they are actually participating in the global market.
Many simulators have gamification features to introduce a degree of competitiveness among users.
Professional day traders use a wide variety of advanced technical tools to get ahead on the market, such as advanced chart patterns, level II price quotes, retracements, extensions, etc.
While beginners might find a hard time with some of the advanced day trading tools, it is nonetheless beneficial to understand their basic applications and potential benefits in the future.
Day traders typically use candlestick chart patterns, which show the opening and closing prices, as well as the highs and lows during a set period of time.
Candlestick charts are versatile technical tools that go well with a number of different indicators, such as:
These are only a handful of indicators commonly used on candlestick charts to measure factors, such as volatility, momentum, and trend strength.
Day trading can be a highly stressful process and the mental aspect of trading can sometimes be even more important than the technical aspects of a strategy.
This is especially true when a trade starts losing money, at which point many traders may panic and try to double down on the stock to recuperate their losses, which is never an advisable course of action.
Most successful traders have stated that a certain degree of emotional coolness and mental fortitude is required for any trader to be successful, as there will inevitably be times when the trader doubts their skills and knowledge of the market entirely.
Keeping a cool head and showing a pragmatic approach are essential to a profitable trading career and beginners should be ready for a lot of trial and error until they consistently achieve desired results.
The fast-paced environment day traders have to deal with on a regular basis can be mentally tasking. Decisions have to be made in a matter of seconds and a number of consecutive unsuccessful trades can have a major impact on the confidence of traders.
This is why it is crucial to cut your losses as quickly as possible and not view unsuccessful trades as major failures. Rather, they are lessons that teach you where your strategy needs work and how to make the necessary adjustments to improve your performance.
Stress is one of the key reasons why some experienced day traders consider that not everyone is cut out for full-time day trading.
The key to overcoming these mental hurdles is to remain calm and collected and maintain discipline even when most of your trades are not panning out well.
Being disciplined and organized is key to a successful day trading career. Day traders have to interact with a lot of data and often trade with multiple screens providing vital information.
Finding the motivation to trade every day can be a bit tough, but visualizing your goals and setting paths can go a long way in providing you with some structure.
Being organized and keeping track of a barrage of data can be easier said than done, but it is crucial to have some structure when it comes to your daily trades.
There are a variety of financial software that can help you stay organized and remove some of the clutter, as too much data can be a nuisance, rather than a help.
Keeping a trading journal and tracking your performance is also a great way to continuously improve your stock picks and subsequent performance, as day trading is a constant learning process - even for seasoned professionals.
Much like regular trading, day trading is subject to taxation in most jurisdictions. Focusing on the United States, these are some important factors to consider when day trading to keep track of your taxes and avoid overpaying wherever possible:
To summarize, let’s review some key advantages and disadvantages of day trading to help determine whether this is the right course of action for your financial objectives.
Stock day trading can be risky, as day trading involves buying and selling in short intervals when the market is highly volatile and even a small mistake can lead to losses.
Yes. Successful stock day traders can make substantial amounts of profit while benefiting from tax deductions if they qualify for a day-trader status
Day trading stocks requires a deep knowledge of the stock market and experience in trading. While anyone can theoretically start day trading, successful traders need to be trained, organized, and realistic in their expectations.