What is day trading?

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Day trading is the practice of making multiple transactions of a security within a single day. Day traders hope to use market volatility to cash in on small profits by trading stocks. While there is significant money to be made in day trading, there is also significant risk.

There are many ways to make money with securities – and day trading is one such way. With increased access to investment apps and tools, reduced fees for trades and data related to securities, many people are becoming more interested in how small moves in the market can yield profits.

But day trading is not for the inexperienced investor. To be successful, you need the right mix of education, experience, and capital—not to mention the discipline to execute a cultured strategy. Here’s a closer look at how to day trade and what you need to know before taking the plunge into these often dangerous waters.

Define day trading

Same day transactions

Day trading is when you buy and sell the same security within the same day. An active trading strategy that uses this approach usually involves making a large number of trades to generate sufficient returns.

Robert Johnson, professor of finance at the Heider College of Business at Creighton University, describes day trading as the practice of “placing numerous bets on short-term price movements in securities. [Day traders] are properly classified as speculators and not investors.”

Benefit of volatility

The hope is that by making these trades you can capitalize on any gains the securities may have experienced during the day. Basically, this approach seeks to take advantage of any short-term price movements experienced by a stock or other security.

Common Day Trading Strategies

Sculpting

Scalping is one of many day trading strategies, and it aims to generate profits from small price movements in the prices of securities (often stocks). The basic rationale behind this approach is that traders may find it easier to profit from small price movements than larger ones.

With this approach, an investor can execute hundreds of transactions per day. Day traders hold these securities for seconds to minutes since trading happens so quickly with this strategy. Trading in large volumes is the key to success with this method.

Anyone using this strategy can benefit from formulating an exit strategy and sticking to it, as one big loss can wipe out all the profits generated during a trading day.

News-based trading

Day traders follow the news to look for conditions that could affect the price of stocks. They must constantly monitor news outlets to look for information they can use to make predictions about how stocks will perform, and then base buy and sell actions on that information.

Traders should keep in mind that a news story can change very quickly as media outlets release updates on highly visible situations.

Quick Tip: Changes in political leaders, sales of companies or leadership, supply shortages and natural disasters are all events that can affect stock values. Be on the lookout for changes in the market when they occur.

Technical analysis

Technical analysis involves examining a security’s price history and trading volume to get a well-informed sense of where it is going next. A trader can get an idea of ​​what the market’s attitude towards a particular security is by reviewing this data and then potentially profit from that information.

Why day trading?

Potential for quick profits

The global asset markets sometimes experience sharp volatility, which means that traders can generate quick profits if they can “time” the market correctly.

By making a large number of trades, a day trader can potentially earn significant profits using this approach.

“If successful, day traders can make a lot of money in a relatively quick time,” says Vinny Yu, co-founder of JAVLIN Invest. “You can also work as much or as little as you want. Some traders can make money by just trading the open and then [taking] the rest of the day.”

However, he stressed that loss management is important to be successful in day trading. He says the preservation of capital is extremely important to not allow small losses to turn into large ones.

Control

Day traders are in charge of monitoring their own portfolio, giving them full control over what they do with their investments. Investors using this approach can make real-time decisions about the securities they want to buy and sell, as well as how many trades they want to make.

“Investors can get cheaper and easier access to stock markets than ever before,” said David Keller, chief market strategist at StockCharts.com. “But that easier access also comes with increased risk. Investors need to educate themselves on the concepts of risk versus reward, especially how to manage risk on individual stocks as well as at the portfolio level through asset allocation. By learning more about market history using charts and technical analysis, day traders can better appreciate how repeatable patterns in price action can be identified and quantified.”

Because day trading can be so risky, day trading investors have a lot to consider. “In addition to reading charts and monitoring news, a good day trader can also recognize opportunities by reading the tape,” says Yu. “The goal of a day trader is of course to make money, but just as important is to hold on to that money and not lose it.”

Risks of day trading

High risk of loss

Most day traders lose money. Many individuals are lured by hopes of generating quick profits but fail to make them materialize. An academic paper, titled “Do Individual Day Traders Make Money? Evidence from Taiwan,” found that “in the typical six-month period, more than eight out of ten day traders lose money.”

At the same time, the paper found that some day traders can consistently generate profits.

“The deck is stacked against the day trader and is stacked in favor of the long-term investor,” says Johnson. “Over the long term, investing in the stock market is a positive sum game. That is, over the long term, the value of stocks, both individually and collectively, generally increases. On the other hand, over the short term, investing in any asset class is a zero-sum game.”

Some traders engage in margin trading, which involves borrowing money to make trades. While this approach can improve profits, it also increases potential losses, so it is an extremely risky approach that most novice traders may want to avoid.

Investors should also keep in mind that if they trade on margin and make at least four day trades within the span of five days, they are classified as a pattern day trader and must follow more rules than other traders would.

Quick tip: Buying on margin is the practice of borrowing money from a brokerage firm for investment transactions. While using this approach to day trading is an option that can give you greater buying power, you also run the risk of owing money when trades don’t work out in your favor.

Volatility

Sharp price movements in the global asset markets can cause losses to accumulate quickly. Rapid price movements can cause the securities purchased by a day trader to lose significant amounts of value, thus generating significant losses.

Tension

Day trading requires intense focus and quick decision-making, which can be exhausting, especially for investors who are lured by the idea of ​​making a quick buck using this approach.

If you want to be successful in day trading, you can also expect to spend a significant amount of time researching, planning and trading.

“Day trading is a full-time job,” says Yu. “So if you think it’s quick and easy money, think again. Day trading requires discipline, patience and emotional stability.”

Investors who want to engage in such activities can benefit from creating a system with specific day trading rules and sticking to them. Doing so will require discipline and commitment, as well as the emotional wherewithal to deal with constant market volatility. It takes time to learn what works and what doesn’t with day trading and to develop a methodology that leads to the kind of profits you want to achieve.

“In my experience, the most successful traders exercise good discipline in their decision making by focusing on the weight of the evidence,” says Keller. “It’s good to consider different perspectives, but at the end of the day, your decision-making process is up to you. Develop a well-articulated checklist for entering and exiting positions, apply that checklist consistently, and find success.”

Aspiring day traders also need to stay on top of regulatory considerations. Like most types of investments, day trading is subject to regulatory oversight by the Financial Industry Regulatory Authority (FINRA) and the Securities Exchange Commission (SEC). This is because day trading involves the buying and selling of securities.

Frequently Asked Questions