What is Day Trading

What is Day Trading (photo: bullsonwallstreet.com)

Years ago, only individuals employed by large financial institutions, brokerages, and trading houses had the ability to engage in active trading in the stock market. However, with the introduction of online trading and the immediate dissemination of news, the playing field has become more even. Retail investors now have the opportunity to attempt to trade like professionals, thanks to user-friendly trading apps and commission-free services like Robinhood, TD Ameritrade, and Charles Schwab.

Day trading has the potential to become a profitable career if executed properly. However, it can be a difficult undertaking for beginners, particularly those without a well-defined strategy. Even experienced day traders may face setbacks and suffer losses.

So, what is day trading exactly, and how does it function?

The Basics of Day Trading

Day trading involves purchasing and selling a group of securities within a single day, or sometimes even within a matter of seconds. It is distinct from traditional investing and instead involves capitalizing on the price fluctuations that naturally occur during a trading session.

Day trading is most frequently observed in the stock market and foreign exchange (forex), where currencies are traded. Day traders typically possess extensive knowledge of trading details and often have ample financial resources. Some day traders take on additional risk by utilizing leverage to increase the size of their positions.

Day traders are keenly aware of factors that can trigger short-term movements in the market. One popular method involves trading based on current events. Scheduled announcements, such as the publication of economic data, corporate earnings reports, or interest rate decisions, are subject to market expectations and psychology. This means that when these expectations are not met or are surpassed, the markets tend to respond with sudden and significant movements, which can prove highly advantageous for day traders.

Day traders employ a variety of intraday strategies, including:

- Scalping: This approach concentrates on capturing multiple small profits from fleeting price movements that take place during the day.

- Range trading: This strategy employs pre-established support and resistance levels in prices to determine when the trader should buy or sell.

- News-based trading: This tactic takes advantage of trading opportunities that arise due to increased volatility surrounding news events.

- High-frequency trading (HFT): These strategies utilize advanced algorithms to capitalize on small or short-term market inefficiencies.

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Why Day Trading Is Controversial

The profit potential of day trading is a frequently discussed subject on Wall Street, with some internet day trading scams tempting novice traders with the promise of large returns in a brief period.

While some individuals may engage in day trading without adequate knowledge, there are those who earn a profitable living through this method, potentially even thriving as a result of the associated risks.

Numerous professional financial advisors and money managers steer clear of day trading, contending that, in the majority of cases, the risk outweighs the potential reward. Furthermore, several financial practitioners and economists argue that any form of active trading strategy is prone to underperform a basic passive index strategy over time, especially when considering taxes and fees.

While it is feasible to generate profits from day trading, the odds of success are naturally lower because it entails risk and necessitates substantial skill. It is also important not to overlook the impact of luck and timing, as a run of misfortune can derail even the most seasoned day trader.

What are the Initial Steps for Becoming a Day Trader?

Professional day traders, those who pursue trading as a career rather than a pastime, are usually well-versed in their field and possess comprehensive knowledge of the market. Here are several prerequisites necessary for achieving success as a day trader.

Understanding of the Market and Market Experience 

People who engage in day trading without comprehending market fundamentals frequently end up losing money. Having a basic comprehension of technical analysis and chart interpretation is beneficial, but without a thorough understanding of the market and its distinct risks, relying solely on charts can be misleading.

Conduct your research and obtain an understanding of the specific details of the products you intend to trade.

Having Sufficient Capital

Smart day traders use only risk capital that they can afford to lose. This helps to protect them from financial ruin and remove emotions from their trading decisions.

Intraday price movements, which can be in pennies or fractions of a cent, often necessitate a significant amount of capital to take advantage of them effectively.

Day traders who intend to use leverage in margin accounts need to have enough cash to do so. Sudden market fluctuations can cause significant margin calls with little warning.

Day Trading Strategies

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The phrase "Day Trading Strategies" means the methods that a trader uses to gain an advantage over the market during a single trading day. Day traders employ various strategies, such as swing trading, arbitrage, and trading news, and they continually refine these approaches until they generate consistent profits and minimize losses.

Furthermore, there are some fundamental principles of day trading that traders should follow, such as choosing their trades carefully, planning their entry and exit points ahead of time and adhering to that plan, and identifying patterns in the trading behavior of their preferred assets in advance.

Strategy Breakdown
Swing TradingHighHigh
Trading NewsMediumMedium


The term "discipline" refers to the ability of day traders to follow their own criteria when making trades. Traders who do not adhere to their own plans often lose money, which is why the adage "Plan the trade and trade the plan" is so important. Discipline is a crucial component of achieving success in day trading.

Day traders depend on market volatility to make profits. They may view a stock as a good investment opportunity if it experiences significant price fluctuations during the trading day. This volatility can be caused by a variety of factors, such as earnings reports, investor sentiment, or general economic or company news.

Day traders also prefer stocks that have high liquidity since it allows them to adjust their position without significantly impacting the stock's price. If the price of a stock rises, traders may choose to buy it, while if the price falls, they may opt to sell it short to profit from the decline.

Regardless of the specific approach a day trader employs, they generally seek to trade stocks that experience significant price movements.

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Who Makes a Living by Day Trading?

The individuals who earn a livelihood through day trading can be broadly classified into two categories: those who work independently, and those who are employed by a larger organization.

The majority of professional day traders who trade for a living are employed by major players in the financial industry, such as hedge funds and the proprietary trading desks of banks and other financial institutions. These traders have an edge due to their access to various resources, such as direct lines to counterparties, sophisticated trading desks, substantial amounts of capital and leverage, and expensive analytical software.

Generally, these traders are seeking quick profits by exploiting arbitrage opportunities and reacting to news events. They have sufficient resources to take advantage of these relatively low-risk day trades before individual traders are able to respond.

The Solo Day Traders

The individual day traders, also known as solo day traders, may handle their own personal funds or trade on behalf of others. While they usually lack a dedicated trading desk, they often maintain close relationships with a brokerage firm through their significant commission fees and access to additional resources.

Nevertheless, due to the restricted nature of their resources, individual traders are unable to directly compete with institutional day traders, and as a result, they must take on more risk. Typically, individual traders utilize technical analysis and swing trades, combined with a certain level of leverage, to generate sufficient profits from small price movements in highly liquid stocks.

Day trading necessitates access to some of the most intricate financial services and instruments available in the market. Day traders usually require the following:

- Access to a trading desk is typically reserved for traders who work for larger institutions or manage substantial amounts of capital.

The trading or dealing desk is essential as it provides these traders with immediate order execution. For instance, when an acquisition is announced, day traders engaged in merger arbitrage can swiftly place their orders on the trading desk before the broader market can take advantage of any price differences.

- Having access to multiple news sources is crucial as news events often provide the most lucrative trading opportunities. It is vital to be among the first to receive breaking news.

In a typical trading room, traders have access to top newswires, 24/7 news coverage from various organizations, and specialized software that constantly scans news sources for crucial information.

- Analytical software is an essential, albeit costly, tool for most day traders. Traders who utilize technical indicators or swing trades often rely more heavily on software than news. The software typically possesses the following features:

  • Automatic pattern recognition: This program identifies technical indicators such as flags, channels, and more complex indicators like Elliott Wave patterns.
  • Genetic and neural applications: These programs use neural networks and genetic algorithms to optimize trading systems and provide more precise predictions of future price movements.
  • Broker integration: Some of these applications can directly interface with the trader's brokerage account, enabling instantaneous or automatic execution of trades. This helps remove emotional biases from trading and enhances trade execution speeds.
  • Backtesting: This feature enables traders to examine how a specific trading strategy would have fared in the past, which can help them predict how it might perform in the future. However, it is worth noting that past performance does not always guarantee future outcomes.
Taken together, these tools provide traders with a competitive advantage over the rest of the market.

Risks of Day Trading

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For the average investor, day trading can be an intimidating prospect due to the multitude of risks involved. The U.S. Securities and Exchange Commission (SEC) has outlined some of the risks associated with day trading, which are outlined below:

"Be ready to endure significant financial losses" is a warning that applies to most day traders. During their initial months of trading, they usually experience substantial financial losses, and many never manage to turn a profit.

Day trading is a highly stressful occupation that requires full-time commitment. To identify short-lived market trends, traders must keep a close eye on dozens of stock prices and fluctuations, which demands intense concentration.

Day traders heavily rely on borrowed funds to execute their trading strategies, utilizing leverage to generate profits. Unfortunately, this approach can result in substantial losses that not only wipe out the trader's original investment, but also leave them in debt.

It is crucial to remain skeptical of purportedly easy profits in day trading. Be wary of hot tips and expert advice from newsletters and websites targeting day traders. Additionally, keep in mind that educational seminars and classes on day trading may have a biased perspective and may not provide an objective evaluation of the risks involved.

Should You Start Day Trading?

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If you're resolute about beginning day trading, then be ready to dedicate yourself to the following actions:

- Ensure that you have some understanding of the trading industry and a clear understanding of your risk tolerance, available capital, and objectives. Be willing to invest the necessary time to practice and refine your strategies. 

- Begin with a small approach, concentrate on a few stocks rather than stretching yourself too thin, as going all-in can complicate your trading strategy and lead to significant losses. 

-.Maintain a composed demeanor and strive to keep emotions out of your trades. Stick to your plan and don't deviate. 

By adhering to these fundamental principles, you may be on your way to establishing a long-lasting career in day trading.

Day Trading Example

A day trade is essentially the same as any other stock trade, with the only difference being that both the purchase and sale of a stock occur within the same day, and sometimes even within seconds of each other.

For instance, let's suppose that a day trader has conducted a technical analysis of a company called Intuitive Sciences Inc. (ISI). The analysis reveals that this stock, which is listed on the Nasdaq 100, has a tendency to increase in value by at least 0.6% on most days when the NASDAQ rises by more than 0.4%. Based on this information, the trader has a reason to believe that today is going to be one of those days.

At market open, the trader purchases 1,000 shares of ISI and patiently waits until the stock reaches a specific price point, typically up 0.6%. As soon as this target is reached, the trader immediately sells the entire holding of ISI, thereby completing a day trade. The actions of the day trader are not related to the potential value of ISI as an investment; rather, they are based on the identification of a trend that can be exploited for profit.

However, if ISI had gone against the trend and lost 0.8%, the trader would still sell their holdings and incur the resulting loss.

How Do I Get Started Day Trading?

A day trader who achieves success comprehends the importance of technical analysis, which involves identifying trading prospects by observing and plotting patterns of price and volume fluctuations in a stock (or any other investment). The long-term trend provides insights into how the stock has performed historically and offers a hint of how it may behave in the near future.

Nowadays, technical analysis is typically conducted with the aid of software packages that assist in creating charts and graphs for this purpose, rather than relying on traditional paper-and-pencil methods.

In addition, a day trader must have a well-defined plan in place before initiating any trades. This entails pre-determining which stocks to trade and establishing acceptable price points for both buying and selling. A successful day trader does not leave room for impulsive decisions.

Lastly, even an individual day trader must possess a fully equipped trading desk that comprises news services, real-time data, and brokerage services essential for executing their plan.

If you plan on trading on margin, you will require a substantial amount of cash on deposit with your broker. However, this approach is not advisable for novices due to the high risk involved, as it can result in the trader becoming penniless and heavily indebted.

A much safer alternative is to begin with an amount of cash that you can afford to lose.

What Is the First Rule of Day Trading?

The primary rule of day trading is to always liquidate a position before the market closes for the day, regardless of the outcome of the trade.

The majority of day traders adhere to this principle, as they refrain from holding onto a losing position overnight with the expectation of recouping their losses.

Furthermore, brokers impose greater margin requirements for overnight trades, necessitating additional capital. This is reasonable because stock prices can fluctuate significantly due to overnight news, resulting in larger trading losses for shareholders.

What Are the Margin Requirements for Day Traders?

In accordance with the regulations established by the Financial Industry Regulatory Authority (FINRA), any individual classified as a pattern day trader and working with a broker-dealer must satisfy a minimum equity requirement of $25,000. This amount must be deposited into the client's account prior to engaging in any day-trading activities and maintained at all times.

What Is Day Trading’s Buying Power?

Buying power pertains to the overall funds at the disposal of an investor for trading securities. It is determined by adding the available margin to the cash held in the account.

In compliance with FINRA guidelines, a client of a broker-dealer who is classified as a pattern day trader may conduct trades worth up to four times their maintenance margin surplus from the previous day's market close.

In conclusion

Day trading can lead to significant gains or heavy losses, making it a highly risky career path. However, both individual and institutional day traders contend that they contribute significantly to the market's efficiency and liquidity.

While day trading may seem appealing to individual investors, those who wish to pursue it must possess the necessary knowledge, resources, and capital to improve their chances of success.

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Source: https://www.investopedia.com

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