In a world where everyone has easy access to online trading, why are there only a few succeeding as day traders? After all, what investor has not dreamed of becoming a day trader—working comfortably at a home computer, being your own boss, watching profits roll in? While many aspire, few actually succeed.
- Day traders actively engage with the market, employing intraday strategies to profit off quick price changes in a given security.
- To become a day trader, you must be sure to be well-enough capitalized and have access to an affordable and functional trading platform.
- Day trading can be a lucrative undertaking, but it also comes with a high degree of risk and uncertainty.
- A thorough understanding of markets, financial securities, and behavioral finance—along with personal discipline and focus—is necessary for success.
What Does a Day Trader Do?
A day trader actively buys and sells securities, often multiple times during the day, but without carrying any open positions to the next day. All buy and sell positions taken during a trading day are squared off on the same day before the market closes. Day traders are different from active traders who may hold a position for multiple days, or from investors who invest for longer periods. Day traders also use leverage to increase their intraday trade exposure.
How To Become A Day Trader
1. Conduct a Self-Assessment
Successful day trading requires a combination of knowledge, skills, and traits as well as a commitment to a lifestyle. Are you adept with mathematical analysis, full of financial knowledge, aware of behavioral psychology (in yourself as well as others), and do you have the stomach for entrepreneurship? Contrary to the perceived notion of an easy life or easy money, day trading actually requires:
- Long working hours
- Very little leave from work
- Continuous self-learning with no guidance
- Risk-taking abilities
- Never-ending commitment to daily activities of the job
The right mindset is the most important (and the very first) requirement in becoming a day trader. Unless you are prepared to devote time, self-learn, and be mentally prepared to take risks and suffer losses, do not try day trading. Books like Trade Your Way to Financial Freedom by Van K. Tharp and The Psychology of Trading by Brett N. Steenbarger are good resources for learning more about day trading and performing a self-assessment.
2. Arrange Sufficient Capital
No one can generate profits consistently. Intermittent and extended losses are part of the day trading game. (For example, a day trader may suffer eight loss-making trades in a row and only recover with profit on the ninth trade.)
To handle these risks, a day trader must have a sufficient cushion of capital. As Van K. Tharp explained in Trade Your Way to Financial Freedom, entering the trading world with only a small amount of money is a sure path to failure. Before quitting your job to trade full time, Tharp recommends having at least $100,000 for trading. Novices can start with smaller amounts, depending upon their selected trading plan, the frequency of trading, and other costs they bear. To actively day trade, it is required that you maintain a balance of $25,000 in your trading account.
3. Understand the Markets
Day traders need a solid foundation of knowledge about how the markets function. From simple details (like exchange trading hours and holidays) to complex details (like the impact of news events, margin requirements, and allowed tradable instruments), a trader needs to have a broad knowledge base.
4. Understand Securities
Stocks, futures, options, ETFs, and mutual funds all trade differently. Without a clear understanding of a security’s characteristics and trading requirements, initiating a trading strategy can lead to failure. For example, traders should know how margin requirements for futures, options, and commodities significantly impact trading capital or how an interim assignment or exercise of an option position can shatter the trading plan completely.
Lack of knowledge about these necessities specific to securities can lead to losses. Aspiring traders should ensure full familiarity with the trading of selected securities.
5. Set up a Trading Strategy
Novice traders entering the world of trading can begin by selecting at least two established trade strategies. Both would act as a backup of each other in case of failure or lack of trading opportunities. One can move on to a greater number of strategies (with more complexities) later, as experience builds up.
The trading world is highly dynamic. Trading strategies can consistently make money for long periods but then fail at any time. One needs to keep a close eye on the effectiveness of the selected trading strategy and adapt, customize, dump, or substitute it depending upon the developments.
6. Integrate Strategy and Plan
Selecting the right trading strategies alone is not sufficient to succeed in the market. The following considerations need to complement the strategy to come up with the trading plan:
- How the strategy will be used (entry/exit strategy)
- How much capital will be used
- How much money per trade will be used
- Which assets will be traded
- How frequently to place trades
7. Practice Money Management
Let’s say you have $100,000 as trading capital and an excellent trading strategy that offers a 70% success rate (seven trades out of 10 are profitable). How much should you spend on your first trade? What if the first three trades are a failure? What if the average record (seven profitable trades out of 10) no longer holds? Or, while trading futures (or options), how should you allocate your capital to margin money requirements?
Money management helps you address these challenges and estimate your potential profitability. Effective money management can help you win even if there are only four profitable trades out of 10. Practice, plan, and structure the trades according to a designated money management and capital allocation plan.
8. Research Brokerage Charges
Day trading usually involves frequent transactions, which result in high brokerage costs. After thorough research, select the brokerage plan wisely. If one intends to play with one or two trades per day, then a per trade basis brokerage plan would be appropriate. If the daily trading volume is high, go for staggered plans (the higher the volume, the lower the effective cost) or fixed plans (unlimited trades for a fixed high charge).
Apart from trade execution, a broker also offers other trading utilities, which include trading platforms, integrated trading solutions like option combinations, trading software, historical data, research tools, trading alerts, and charting applications with technical indicators and several other features. Some features may be free while some may come at a cost that can eat into your profits.
It is advisable to select the features depending upon your trading needs and avoid subscribing to ones that are not needed. Novices should start with the low-cost basic brokerage package matching their initial trading needs and later opt for upgrades to other modules when needed.
9. Simulate and Backtest
Once the plan is ready, simulate it on a test account with virtual money (most brokers offer such test accounts). Alternatively, one can backtest the strategy on historical data. For a realistic assessment, keep consideration for brokerage costs and the subscription fee for various utilities.
10. Start Small and Then Expand
Even if you have sufficient money and sufficient experience, don’t play big on the first trades of a new strategy. Try out a new strategy with a smaller amount and increase the stakes after tasting success. Remember, markets and trading opportunities will remain forever, but money, once lost, may be difficult to reaccumulate. Start small, test to establish, and then go for the big ones.
The Bottom Line
Aspiring traders should beware of websites and courses that promise foolproof day trading success or endless profits. The limited percentage of day traders who have managed to be successful do so by investing their time and efforts into building trading strategies and following them religiously.
Day traders are on their own in this big trading world. Before giving up your job to become a day trader, be sure that you have the motivation to continuously learn, design your trading strategies, and take accountability for your decisions and actions. If you're looking to jump into the world of day trading, you can use one of the best stock brokers for day trading.