What is Day Trading?
Last updated on June 9th, 2015
Day trading is the buying or selling and subsequent closing of a position in a security within the confines of a single trading session in attempting to profit from relatively small fluctuations in price. Day traders may take trades that last from minutes or hours and even complete a trade within a matter of seconds. An intraday price move of 0.5% of the total value of the instrument or less could be very profitable for a day trader.
Because a day trader will often use leverage to make the most of their capital, their profits and losses are potentially magnified and therefore it is crucial for them to have a strong risk plan in place in order to protect themselves from a string of losing trades. On the flip side of the coin, a consistent day trader can use leverage to their advantage as the sum of many smaller trades magnified in this way can produce excellent returns over a relatively short period of time.
THE WHAT, WHERE & HOW
Where there is a market, usually there will also be a day trader. Day traders might choose to trade stocks, options, forex or futures products. And the methods and day trading strategies they use are just as varied. Some look for candlestick price patterns in their charts such as head and shoulders or shooting stars. Others might trade trend lines. Then there’s how a trader goes about profiting from their charts. Some scalp (taking very, very small profits each time), some position trade (looking for bigger moves). Others trade inter-product spreads (where there’s a relationship between two markets) and there are traders who only trade news and economic releases.
KNOW THE COSTS
Because of the frequency of day trading – traders might take 10’s or 100’s of individual trades per week – the associated costs are liable to be much higher. Whilst the commissions for each trade are often competitive for day trading and are scaled based on the number of trades you place in a set period, the sheer frequency of trading can mean that those costs can quickly escalate. So trading efficiently and to a set plan is often going to be preferable to trading randomly and getting sucked into the dreaded “over-trading” mode. Over-trading can occur when markets are moving rapidly and a trader doesn’t want to miss out. The other cost involved is in capital. From the outset it should be clear that there’s an increased level of risk with the leverage involved in trading a margin account (where only a portion of the cost of a product is require to place a trade), but the frequency of trading is rarely taken into consideration. A trader might say only risk 1% of their trading capital per trade, but if they usually take at least 10 trades per day, is this a sustainable level of risk to be taking?
Because of the frequency of day trading, when things go wrong they can spiral out of control if you don’t have a firm grasp on your own emotions. With investing or even swing trading, positions that turn bad can be slept on at least. With day trading you might take one losing trade after the next, the compounding emotions of which causing you to deviate from your strategy and trade in an erratic and rash manner. Coupling leverage with out of control emotional trading is a recipe for disaster and account balances can disappear in next to no time.
The essence of day trading is profiting from small but frequent price fluctuations and leveraging trading capital to make bigger profits on these fluctuations. Markets have a habit of “finding out” day traders who think they have what it takes but really don’t have the knowledge or experience to trade well. However, a trader who is properly capitalized, has a well-defined strategy and risk plan and is able to control their emotions in order to stick to their plan even under severely stressful situations, is likely to be well-suited to day trading and benefit from the potential to achieve success in a short space of time.
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