It's the question at the tip of every aspiring day trader’s tongue: How much money can I really earn from day trading?
Since most day traders do not disclose their actual trading results to anyone but the IRS, an exact answer to how much money an average day trader makes is impossible to answer. The results, moreover, will vary widely given the various trading strategies, risk management practices, and the amount of capital individual traders are working with.
To be sure, it is very easy to lose money day trading, which is why we recommend educating yourself as much as possible before you even think about trying it. In their 2011 research paper "The Behavior of Individual Investors," Professors Brad M. Barner and Terrance Odean at the University of California, Berkeley revealed that individual investors who traded actively and speculatively without diversified portfolios typically lost money over time. Day traders can also incur high fees from transaction costs, so picking the right broker and creating a manageable trading strategy with proper risk management is very important.
- Day trading is a risky but potentially lucrative activity, where traders try to take advantage of intraday price movements and trends.
- Several factors will come into play in determining your potential upside from day trading, including starting capital amount, strategies used, the markets you are active in, and a bit of luck.
- Real day traders take their job seriously and can maintain a nice living if they remain objective and disciplined and stick with their strategy.
What Day Traders Do
Day traders make money by buying stock, commodities, currencies or other trade-able securities and holding them for a short period of time— anywhere from a few minutes to a few hours—before selling them off again. Day traders usually enter and exit trading positions within the day and rarely hold positions overnight, except in the Forex Market. The focus is on profiting from short-term price fluctuations. Day traders can also use leverage to give themselves greater power to buy and sell. This can be extremely risky, so beginners should not attempt this strategy.
One of the key components of locking in your gains and minimizing your losses is setting stop/loss and profit-taking points for your trades and not taking on too much risk per trade. Professional traders like David Green recommend not risking more than 1% per trade based on the size of your portfolio. If your portfolio is $50,000, the most you should risk per trade should be $500. Not letting one bad trade wipe you out is key to managing your risk. If you stick to the 1% risk strategy and set your stop/loss and profit-taking points, you can limit your losses to 1%, and take your gains at 1.5%, but it takes discipline.
How to Get Started in Day Trading
Getting started in day trading is not like dabbling in investing. Any would-be investor with a few hundred dollars can buy some stock in a company they believe in and keep it for months or years. Under FINRA rules, pattern day traders in the equities market must maintain a minimum of $25,000 in their accounts and will be denied access to the markets if the balance drops below that level. This means day traders must have enough capital on top of that to really make a profit. And because day trading requires a lot of focus, it is not compatible with keeping a day job.
Most day traders must be able to live off their profits from trading and be prepared to risk their own capital every day to make those profits. In addition to the minimum balance required, prospective day traders need to be connected to an online broker or trading platform and have the right software to track their positions, do research, and log their trades. Brokerage commissions and taxes on short-term capital gains can also add up, so day traders need to factor all their costs into their trading activities to determine if they can do it profitably.
Earning Potential and Career Longevity
An important factor that can influence earnings potential and career longevity are whether you day trade independently or for an institution such as a bank or hedge fund. Traders working at an institution have the benefit of not risking their own money. They are also typically far better capitalized and have access to advantageous information and tools. There are also many independent trading firms that allow day traders access to their platforms and software, but require the traders to risk their own capital as well.
Other important factors that contribute to a day trader's earnings potential include:
- Markets you trade: Different markets have different advantages. Stocks are generally the most capital-intensive asset class. However, you can start trading with less capital with other asset classes, such as futures or forex.
- How much capital you have: If you start with $3,000, your earning potential is much less than someone who starts at $30,000.
- How much you put into training: To achieve consistent income—where you have a solid trading plan and are able to implement it—it will likely take a year or more if you dedicate yourself to it full time. If you only practice part-time, it may take a number of years to develop real consistency and attain satisfactory returns.
Of course, there are millions of independent day traders worldwide who work for themselves from their home offices and are able to earn a living. Some have even become very wealthy, but there are no guarantees. Practice, developing a strategy, and managing your risk can help get you on your way.
Example of a Day Trading Strategy in Action
Consider a strategy for day trading in which the stop/loss is $0.04 and the target is $0.06. If your account balance is $30,000, the trader decides that his maximum risk per trade is $300. With a $0.04 stop loss, you can take 7,500 ($300/$0.04) shares on each trade and stay within your $300 risk cap (not including commissions).
Remember, to take 7,500 shares, the share price must be below $16 (attained by $120,000 in buying power divided by 7,500 shares). If the per-share price is more than $16, you'll need to take fewer shares. The stock also needs to have enough volume for you to take such a position.
Here's how such a trading strategy might play out:
- 60 trades were winners/profitable: 60 x $0.06 x 7,500 shares = $27,000.
- 45 trades were losers: 45 x $0.04 x 7500 shares = ($13,500).
- Your gross profit would be $27,000 - $13,500 = $13,500.
- Your net profit, which includes the cost of commissions, is $13,500 - commissions ($30 x 100 = $3,000) = $10,500 for the month.
Of course, this is all theoretical. Several factors will reduce your take-home profit. The reward-to-risk ratio of 1.5 is used because it is fairly conservative and reflective of the opportunities that occur all day, every day in the stock market.
The starting capital of $30,000 is also just an approximate balance to start day trading stocks; you'll need more if you wish to trade higher-priced stocks.
The Bottom Line
Day trading is not a hobby or an activity that you can do every once in a while if you are serious about doing it to make money. While there is no guarantee that you will make money day trading or be able to predict your average rate of return over any period of time, there are strategies you can master that will help you set yourself up to lock in gains while minimizing losses.
It takes discipline, capital, patience, training, and risk management to be a day trader and a successful one at that. If you're interested in becoming a day trader, review the best stock brokers for day traders as the first step is to choose the right broker for your needs.