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, has 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 need a well-planned strategy. And be aware that even the most seasoned day traders can hit rough patches and experience losses.
The Basics of Day Trading
Day trading means buying and selling a batch of securities within a day or even within seconds. It has nothing to do with investing in the traditional sense. It exploits the inevitable up-and-down price movements that occur during a trading session.
Day trading is most common in the stock markets and on the foreign exchange (forex), where currencies are traded.
Day traders are typically well-educated in the minutia of trading and are well-funded. Many of them add a level of risk by using leverage to increase the size of their stakes.
Day traders are attuned to events that cause short-term market moves. Trading based on the news is one popular technique. Scheduled announcements, such as releasing economic statistics, corporate earnings, or interest rate announcements, are subject to market expectations and psychology. That is, markets react when those expectations are not met or exceeded–usually with sudden, significant moves that can benefit day traders.
Day traders use numerous intraday strategies. These strategies include:
- Scalping: This strategy focuses on making small profits on ephemeral daily price changes.
- Range trading: This strategy uses pre-determined support and price resistance levels to determine the trader’s buy and sell decisions.
- News-based trading: This strategy seizes trading opportunities from the heightened volatility around news events.
- High-frequency trading (HTF): These strategies use sophisticated algorithms to exploit small or short-term market inefficiencies.1
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 quickly.
Some people day-trade without sufficient knowledge. But some day traders 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 tend to underperform a more basic passive index strategy over time, especially after fees and taxes are considered.
Profiting from day trading is possible, but the success rate is inherently lower because it is risky and requires considerable skill. And take into account the role that luck and good timing play. A stroke of bad luck can sink even the most experienced day trader.
How Does a Day Trader Get Started?
Professional day traders–those who trade for a living rather than as a hobby–are typically well-established in the field.2 They usually have in-depth knowledge of the marketplace, too. Here are some of the prerequisites required to be a successful day trader.
Knowledge and Experience in the Marketplace
Individuals who attempt to day-trade without understanding market fundamentals often lose money. Working knowledge of technical analysis and chart reading is a good start. But charts can only be deceiving with a deep understanding of the market and its unique risks.
Do your due diligence and understand the particular ins and outs of the products you trade.
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.
Significant 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.
Day Trading Strategies
A trader needs to have an edge over the rest of the market. Day traders use several 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 and stick to the plan. Identify patterns in the trading activities of your options in advance.
Many day traders lose money because they fail to make trades that meet their criteria. As the saying goes, “Plan the trade and trade the plan.” Success is only possible with 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 several reasons, including an earnings report, investor sentiment, or general economic or company news.
Day traders also like highly liquid stocks because they can change their position without altering the stock price. 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 the day trader’s technique, 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 working alone and working for a larger institution.
Most day traders who trade for a living work for prominent players like hedge funds and the proprietary trading desks of banks and financial institutions. These traders have an advantage because they can access direct lines to counterparties, a trading desk, large amounts of capital and leverage, and expensive analytical software.
These traders typically seek 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 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.