Day Trading: The Basics and How to Get Started

There was a time years ago when the only people able to trade actively in the stock market were those working for large financial institutions, brokerages, and trading houses. The arrival of online trading, along with instantaneous dissemination of news, have leveled the playing—or should we say trading—field. The easy-to-use trading apps and 0% commissions of services like Robinhood, TD Ameritrade, and Charles Schwab have made it easier than ever for retail investors to attempt to trade like the pros.

Day trading can turn into a lucrative career (as long as you do it properly). But it can be challenging for novices—especially those who don’t have a well-planned strategy. And be aware that even the most seasoned day traders can hit rough patches and experience losses.

What Is Day Trading?

Day trading is a fast-paced form of investing where individuals buy and sell securities within the same trading day. The primary goal is to profit from short-term price movements in stocks, options, futures, and other financial instruments. Day traders typically use a combination of strategies and analysis, including technical analysis, which focuses on past price movements and trading patterns, and momentum; which involves capitalizing on short-term trends and reversals. Unlike long-term investors, day traders are less concerned with the fundamental value of the securities and more focused on capturing immediate gains from market fluctuations.

The appeal of day trading lies in its potential for quick gains, but it’s also associated with significant risks. It requires a solid understanding of the markets and the ability to make fast, informed decisions. Day traders need to stay abreast of market headlines, economic reports, and other factors that can influence stock prices throughout the day. They often employ leverage, borrowing money that can increase both potential profits and potential losses. As such, day trading is generally not recommended for inexperienced traders or those without the financial capacity to absorb losses.

It is also important to understand the regulatory environment around day trading. In the United States, the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) set rules for “pattern day traders,” defined as those who execute four or more day trades within five business days. These traders must maintain a minimum cash balance of $25,000 in their brokerage account. Such regulations are designed to ensure that only those with sufficient resources and understanding participate in this high-stakes activity.

The Basics of Day Trading

Day trading is most commonly observed in the stock markets and on the foreign exchange (forex), where currencies are traded.

Day traders are attuned to events that cause short-term market moves. Trading based on the news is one popular technique. Scheduled announcements like releasing economic statistics, corporate earnings, or interest rate changes are subject to market expectations and market psychology. That is, markets react when those expectations are unmet or exceeded—usually with sudden, significant moves that can benefit day traders.

Day Trading Strategies

A trader needs to have an edge over the rest of the market. Day traders use any of a number of strategies, including swing trading, arbitrage, and trading news. They refine these strategies until they produce consistent profits and limit their losses.

There also are some basic rules of day trading that are wise to follow: Pick your trading choices wisely. Plan your entry and exit points in advance and stick to the plan. Identify patterns in the trading activities of your choices in advance.

Day traders use numerous intraday strategies. These strategies include:

  • Scalping: This strategy focuses on making many small profits on ephemeral price changes that occur throughout the day. Arbitrage is a type of scalping that seeks to profit from correcting perceived mispricings in the market.
  • Range/Swing trading: This strategy uses predetermined support and resistance levels in prices to determine the trader’s buy and sell decisions.
  • News-based trading: This strategy seizes trading prospects from the heightened volatility that occurs around news events or headlines as they come out. One type of news-based trading involves whether a merger or acquisition that has been announced will go through or not.
  • High-frequency trading: These strategies use sophisticated algorithms to exploit small or short-term market inefficiencies.

Why Day Trading Is Controversial

The profit potential of day trading is an oft-debated topic on Wall Street. Internet day-trading scams have lured amateurs by promising enormous returns in a short period of time.

Some people day-trade without sufficient knowledge. But there are day traders who make a successful living despite—or perhaps because of—the risks.

Many professional money managers and financial advisors shy away from day trading. They argue that, in most cases, the reward does not justify the risk. Moreover, many economists and financial practitioners argue that active trading strategies of any kind tend to underperform a more basic passive index strategy over time especially after fees and taxes are taken into account.

Profiting from day trading is possible, but the success rate is inherently lower because it is risky and requires considerable skill. And don’t underestimate the role that luck and good timing play. A stroke of bad luck can sink even the most experienced day trader.

How To Start Day Trading

Professional day traders—those who trade for a living rather than as a hobby—are typically well established in the field. They usually have in-depth knowledge of the marketplace, too. Here are some of the prerequisites required to be a successful day trader.

1) Gain Lots of Market Knowledge and Experience

Individuals who attempt to day-trade without an understanding of market fundamentals often lose money. A working knowledge of technical analysis and chart reading is a good start. But without a deep understanding of the market and its unique risks, charts can be deceiving.

Do your due diligence and understand the particular ins and outs of the products you trade.

2) Make Sure To Have Sufficient Capital

Wise day traders use only risk capital that they can afford to lose. This protects them from financial ruin and helps eliminate emotion from their trading decisions.

A large amount of capital is often necessary to capitalize effectively on intraday price movements, which can be in pennies or fractions of a cent.

Adequate cash is required for day traders who intend to use leverage in margin accounts. Volatile market swings can trigger big margin calls on short notice.

3) Learn Trading Discipline

Many day traders end up losing money because they fail to make trades that meet their own criteria. As the saying goes, “Plan the trade and trade the plan.” Success is impossible without discipline.

To profit, day traders rely heavily on market volatility. A day trader may find a stock attractive if it moves a lot during the day. That could happen for a number of different reasons, including an earnings report, investor sentiment, or even general economic or company news.

Day traders also like stocks that are highly liquid because that gives them the chance to change their position without altering the price of the stock. If a stock price moves higher, traders may take a buy position. If the price moves down, a trader may decide to sell short so they can profit when it falls.

Regardless of what technique a day trader uses, they’re usually looking to trade a stock that moves (a lot).

Who Makes a Living by Day Trading?

There are two primary divisions of professional day traders: those who work alone, and/or those who work for a larger institution.

Most day traders who trade for a living work for large players like hedge funds and the proprietary trading desks of banks and financial institutions. These traders have an advantage because they have access to resources such as direct lines to counterparties, a trading desk, large amounts of capital and leverage, and expensive analytical software.

These traders are typically looking for easy profits from arbitrage opportunities and news events. Their resources allow them to capitalize on these less risky day trades before individual traders can react.

The Solo Day Traders

Individual traders often manage other people’s money or simply trade with their own. Few have access to a trading desk, but they often have strong ties to a brokerage due to the large amounts they spend on commissions and access to other resources.

However, the limited scope of these resources prevents them from competing directly with institutional day traders. Instead, they are forced to take more risks. Individual traders typically day trade using technical analysis and swing trades—combined with some leverage—to generate adequate profits on small price movements in highly liquid stocks.

Access to a Trading Desk

This is usually reserved for traders who work for larger institutions or those who manage large amounts of money.

The trading or dealing desk provides these traders with instantaneous order execution, which is crucial. For example, when an acquisition is announced, day traders looking at merger arbitrage can place their orders before the rest of the market is able to take advantage of the price differential.

Multiple News Sources

News provides most of the opportunities. It is imperative to be the first to know when something significant happens.

The typical trading room has access to all of the leading newswires, constant coverage from news organizations, and software that constantly scans news sources for important stories.

Analytical Software

Trading software is an expensive necessity for most day traders. Those who rely on technical indicators or swing trades rely more on software than on news. This software may be characterized by the following:

  • Automatic pattern recognition: This trading program identifies technical indicators like flags and channels, or more complex indicators such as Elliott Wave patterns.
  • Genetic and neural applications: These programs use neural networks and genetic algorithms to perfect trading systems and make more accurate predictions of future price movements.
  • Broker integration: Some of these applications even interface directly with the brokerage, allowing for instantaneous and even automatic execution of trades. This eliminates emotion from trading and improves execution times.
  • Backtesting: This allows traders to look at how a certain strategy would have performed in the past to predict more accurately how it will perform in the future. Keep in mind that past performance is not always indicative of future results.

Combined, these tools provide traders with an edge over the rest of the marketplace.

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