Put simply, day trading refers to the practice of buying and selling different financial instruments with the intent of making a profit on the same day. It involves opening trades and closing them before the end of the day – whether they post a profit or a loss.
It is also referred to as active trading and is a form of short-term investing.
Interestingly, day trading was a reserve of the relatively large financial institutions or brokerage and trading houses that served accredited/high net worth investors. Today, however, virtually anyone can be a day trader.
Relaxed regulatory policies, strides in open-sourced trading technology, increased number of liquidity providers, the emergence of online trading houses, and an increased number of trading platforms have leveled the playing field and allowed for the entry of retail traders.
Note, however, that while these may have opened up the market, they have not made day trading any easier. On the contrary, faster connectivity between different industry players has contributed to higher volatility. There has also been a rise in the number and extent of trading taxes.
But by the end of this day trading guide, you will have known how day trading works, what you need to start trading, popular day trading strategies, and how to day trade for a living.
Who is a day trader?
A day trader is a person (sole trader or specialist attached to a trading house or financial institution) that is involved in intraday trading and does not hold open positions overnight. They embrace different day strategies that involve opening and closing multiple trades throughout the day and avoid the risks of overnight trading.
You do not need special qualifications to become a day trader because it is a trader category, not a specialist career profession. The New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA) define a day trader based on the frequency of their trades. They both classify you as a day trader if you place and close more than four trades daily on a 5-day week.
How does day trading work?
It involves a hands-on approach to trading such types of financial instruments as stocks, forex, cryptocurrencies, futures, and options. When day trading, you are basically taking advantage of the price fluctuations of your chosen instrument. In most instances, you will be buying or shorting trades and holding on to them for a short period – milliseconds to a few hours or throughout the day.
Day trading involves entering into a buy/sell position, holding on to it, and closing it as soon as it turns profitable. But not every position you enter into will be profitable. At times you will be forced to close a losing trade to avoid further losses.
What you need to become a day trader
As mentioned hereinabove, you do not need special qualifications to become a day trader. There, however, are several must-haves that you need to succeed as a day trader and live off day trading. They include:
- Trading knowledge and experience:
To succeed as a day trader, you need to know more than just how to open and close a trade. You need a deep understanding of the financial instruments you are trading and rich experience interpreting charts and how different market dynamics affect a trading instrument’s price direction.
- Enough capital:
Day trading is one of the riskiest forms of trade, hence the reason they are advised to only invest what they can afford to lose. But, on the other hand, you are required to have significant capital resources if you have hope to make tangible earnings from the trade. Note that when day trading, you are ideally closing trades as soon as they post marginal profits. In such a case, you will need to have committed a significant amount of capital to the trade if you are to generate a life-sustaining income.
- Winning strategy:
A winning strategy refers to a plan of action that gives you an edge over the markets. It can also be referred to a trading style that helps you score more wins over losses. Note that a good winning strategy is developed over time and through backtests, actual trades, and regular fine-tuning. Virtually all the popular day trading platforms provide traders with free demo practice accounts that you can you use to practice trading as well as test and improve the efficiency of your trading strategy.
- Access to a broker/trading desk:
You will also need access to a reliable and inexpensive trading platform in the form of a direct broker or trading house. And when looking for a broker, consider such factors as whether they have direct access to the market, their trading fees and commissions, number and financial products on offer, and their transaction processing speeds.
- Discipline and patience
You need a lot of discipline and patience when day trading. Discipline, in this case, refers to the practice of sticking to a proven trading method/strategy, avoiding emotional trading, following a winning routine, knowing when to quit, and putting a handle on your emotions by avoiding greed or chasing markets.
Popular day trading strategies
To succeed as a day trader, one of the most important things you have to do is come up with a unique but highly effective trading strategy. This refers to a trading technique that takes into account such factors as your risk tolerance and investment goals. It should also be flexible enough to align with different market conditions and your preferred trading instrument. Some of the most popular day trading strategies include:
i) Scalping: This is arguably one of the most popular day trading strategies. It is designed to keep trading losses at a minimum, which also translates to maintaining profits at a similar minimum. Scalping involves opening trade and closing it immediately it shows small profits – leaving no room for reversals. The opposite is also true as you have to close a trade as soon it posts a loss.
ii) Momentum trading: When momentum trading, you will be timing and entering a position at the beginning of a price trend and exiting as soon it peaks and stagnates or shows reversal signs. Here, the beginning of a trend refers to the point at which an instrument is gaining steam and drawing in large volumes of buyers and sellers. In most cases, it is used alongside new trading where you can anticipate the direction of momentum based on the news coming in.
iii) Arbitrage trading: It involves buying one instrument at a lower price and selling it immediately on an exchange where it has a higher price and profiting from the difference in price. For instance, if gold is cheaper by even a few dollars or cents on the New York stock exchange. You may consider opening two simultaneous trades – a buy order on the New York stock exchange and a sell order on the Tokyo stock exchange. Given the marginal price differences involved, you have to commit enough funds to the trade to cover the transaction fees and earn you tangible profit.
iv) News trading: News trading involves opening and closing trades based on news and announcements and anticipated market reaction. When trading news, you have to be expertly experienced in interpreting breaking news quickly, basing it on market expectations, and judging how the market will react.
For instance, if Apple publishes half-year profits reports that exceed analyst expectations, you understand that this will cause market excitement and kick off a bull rally. Buy immediately after the announcement and ride the momentum to sell at the peak price.
Essential tools for every day trader
In addition to trading knowledge and mastery of a trading strategy, there are several must-have tools every day trader must have. These are critical to your trading experience and often play a key role in determining your win-loss ratio. They complement your trading knowledge and strategy and include:
- A reliable broker: You will need to ally yourself with a reliable broker. This ideal broker must have direct access to the market and guarantee the fastest transaction processing speeds.
- Real-time market data: You will need access to a constant stream of real-time market data. In most cases, a broker will provide you with access to the type of data you want on demand. You may also consider subscribing to premium financial data and news platforms like Bloomberg and Capital IQ.
- Speedy internet: Trading sentiments and price directions shift fast, you need equally fast and reliable internet speeds if you are to keep up.
- Trading software: The day trading niche is currently dominated by trading algorithms. To keep up or at least have a fighting chance, you too will need access to premium trading software. These may range from scanning software, charting software, and breaking news software.
Day trading for a living
You can choose to trade solo or perhaps join a trading house to access greater trading capital if you have the required experience. Note, however, that turning day trading from a hobby to a job takes time, effort, and a lot of persistence.
It is hard, but it is not impossible. And the first steps to living off day trading involve taming your emotions, coming up with and perfecting a trading strategy, and committing to constant self-evaluation and improvement.
The bottom line
Day trading is risky, but also highly rewarding to anyone that has perfected a strategy and understands how it works. Note that a principled mindset and access to all the trading tools will point you in the right direction. But it takes unrelenting self-evaluation and regular improvements to turn the practice from a living to a career.