There was a time years ago when the only people able to trade actively in the stock market were those working for large financial institutions, brokerages, and trading houses. The arrival of online trading, along with instantaneous dissemination of news, have leveled the playing—or should we say trading—field. The easy-to-use trading apps and 0% commissions of services like Robinhood, TD Ameritrade, and Charles Schwab have made it easier than ever for retail investors to attempt to trade like the pros.
Day trading can turn into a lucrative career (as long as you do it properly). But it can be challenging for novices—especially those who don't have a well-planned strategy. And be aware that even the most seasoned day traders can hit rough patches and experience losses.
So, what exactly is day trading, and how does it work?
- Day traders buy and sell stocks or other assets during the trading day in order to profit from the rapid fluctuations in prices.
- Day trading employs a wide variety of techniques and strategies to capitalize on these perceived market inefficiencies.
- Day trading is often informed by technical analysis of price movements and requires a high degree of self-discipline and objectivity.
What Is Day Trading?
The Basics of Day Trading
Day trading means buying and selling a batch of securities within a day, or even within seconds. It has nothing to do with investing in the traditional sense. It is exploiting the inevitable up-and-down price movements that occur during a trading session.
Day trading is most common in the stock markets and on the foreign exchange (forex) where currencies are traded.
Day traders are typically well-educated in the minutia of trading and tend to be well funded. Many of them add an additional level of risk by using leverage to increase the size of their stakes.
Day traders are attuned to events that cause short-term market moves. Trading based on the news is one popular technique. Scheduled announcements such as the release of economic statistics, corporate earnings, or interest rate announcements are subject to market expectations and market psychology. That is, markets react when those expectations are not met or are exceeded—usually with sudden, significant moves which can greatly benefit day traders.
Day traders use numerous intraday strategies. These strategies include:
- Scalping: This strategy focuses on making numerous small profits on ephemeral price changes that occur throughout the day.
- Range trading: This strategy uses pre-determined support and resistance levels in prices to determine the trader's buy and sell decisions.
- News-based trading: This strategy seizes trading opportunities from the heightened volatility that occurs around news events.
- High-frequency trading (HTF): These strategies use sophisticated algorithms to exploit small or short-term market inefficiencies.
Why Day Trading Is Controversial
The profit potential of day trading is an oft-debated topic on Wall Street. Internet day-trading scams have lured amateurs by promising enormous returns in a short period of time.
Some people day-trade without sufficient knowledge. But there are day traders who make a successful living despite—or perhaps because of—the risks.
Many professional money managers and financial advisors shy away from day trading. They argue that, in most cases, the reward does not justify the risk. Moreover, many economists and financial practitioners argue that active trading strategies of any kind tend to underperform a more basic passive index strategy over time especially after fees and taxes are taken into account.
Profiting from day trading is possible, but the success rate is inherently lower because it is risky and requires considerable skill. And don’t underestimate the role that luck and good timing play. A stroke of bad luck can sink even the most experienced day trader.
How Does a Day Trader Get Started?
Professional day traders—those who trade for a living rather than as a hobby—are typically well established in the field. They usually have in-depth knowledge of the marketplace, too. Here are some of the prerequisites required to be a successful day trader.
Knowledge and Experience in the Marketplace
Individuals who attempt to day-trade without an understanding of market fundamentals often lose money. A working knowledge of technical analysis and chart reading is a good start. But without a deep understanding of the market and its unique risks, charts can be deceiving.
Do your due diligence and understand the particular ins and outs of the products you trade.
Wise day traders use only risk capital that they can afford to lose. This protects them from financial ruin and helps eliminate emotion from their trading decisions.
A large amount of capital is often necessary to capitalize effectively on intraday price movements, which can be in pennies or fractions of a cent.
Adequate cash is required for day traders who intend to use leverage in margin accounts. Volatile market swings can trigger big margin calls on short notice.
Day Trading Strategies
A trader needs to have an edge over the rest of the market. Day traders use any of a number of strategies, including swing trading, arbitrage, and trading news. They refine these strategies until they produce consistent profits and limit their losses.
There also are some basic rules of day trading that are wise to follow: Pick your trading choices wisely. Plan your entry and exit points in advance and stick to the plan. Identify patterns in the trading activities of your choices in advance.
Many day traders end up losing money because they fail to make trades that meet their own criteria. As the saying goes, “Plan the trade and trade the plan.” Success is impossible without discipline.
To profit, day traders rely heavily on market volatility. A day trader may find a stock attractive if it moves a lot during the day. That could happen for a number of different reasons, including an earnings report, investor sentiment, or even general economic or company news.
Day traders also like stocks that are highly liquid because that gives them the chance to change their position without altering the price of the stock. If a stock price moves higher, traders may take a buy position. If the price moves down, a trader may decide to sell short so they can profit when it falls.
Regardless of what technique a day trader uses, they’re usually looking to trade a stock that moves (a lot).
Who Makes a Living by Day Trading?
There are two primary divisions of professional day traders: those who work alone, and/or those who work for a larger institution.
Most day traders who trade for a living work for large players like hedge funds and the proprietary trading desks of banks and financial institutions. These traders have an advantage because they have access to resources such as direct lines to counterparties, a trading desk, large amounts of capital and leverage, and expensive analytical software.
These traders are typically looking for easy profits from arbitrage opportunities and news events. Their resources allow them to capitalize on these less risky day trades before individual traders can react.
The Solo Day Traders
Individual traders often manage other people’s money or simply trade with their own. Few have access to a trading desk, but they often have strong ties to a brokerage due to the large amounts they spend on commissions and access to other resources.
However, the limited scope of these resources prevents them from competing directly with institutional day traders. Instead, they are forced to take more risks. Individual traders typically day trade using technical analysis and swing trades—combined with some leverage—to generate adequate profits on small price movements in highly liquid stocks.
Day trading demands access to some of the most complex financial services and instruments in the marketplace. Day traders typically require all of the following:
Access to a Trading Desk
This is usually reserved for traders who work for larger institutions or those who manage large amounts of money.
The trading or dealing desk provides these traders with instantaneous order execution, which is crucial. For example, when an acquisition is announced, day traders looking at merger arbitrage can place their orders before the rest of the market is able to take advantage of the price differential.
Multiple News Sources
News provides most of the opportunities. It is imperative to be the first to know when something significant happens.
The typical trading room has access to all of the leading newswires, constant coverage from news organizations, and software that constantly scans news sources for important stories.
Trading software is an expensive necessity for most day traders. Those who rely on technical indicators or swing trades rely more on software than on news. This software may be characterized by the following:
- Automatic pattern recognition: This trading program identifies technical indicators like flags and channels, or more complex indicators such as Elliott Wave patterns.
- Genetic and neural applications: These programs use neural networks and genetic algorithms to perfect trading systems and make more accurate predictions of future price movements.
- Broker integration: Some of these applications even interface directly with the brokerage, allowing for instantaneous and even automatic execution of trades. This eliminates emotion from trading and improves execution times.
- Backtesting: This allows traders to look at how a certain strategy would have performed in the past to predict more accurately how it will perform in the future. Keep in mind that past performance is not always indicative of future results.
Combined, these tools provide traders with an edge over the rest of the marketplace.
Risks of Day Trading
For the average investor, day trading can be a daunting proposition because of the number of risks involved. The U.S. Securities and Exchange Commission (SEC) highlights some of the risks of day trading, which are summarized below:
- Be prepared to suffer severe financial losses: Day traders typically suffer severe financial losses in their first months of trading, and many never make a profit.
- Day trading is an extremely stressful full-time job: Watching dozens of ticker quotes and price fluctuations to spot fleeting market trends demands great concentration.
- Day traders depend heavily on borrowing money: Day-trading strategies use the leverage of borrowed money to make profits. Many day traders not only lose all of their own money, they wind up in debt.
- Don’t believe claims of easy profits: Watch out for hot tips and expert advice from newsletters and websites catering to day traders and remember that educational seminars and classes about day trading may not be objective.
Should You Start Day Trading?
If you're determined to start day trading, be prepared to commit to the following steps:
- Make sure you come in with some knowledge of the trading world and a good idea of your risk tolerance, capital, and goals.
- Be prepared to put in the time to practice and perfect your strategies.
- Start small. Focus on a few stocks rather than wearing yourself thin. Going all out will complicate your trading strategy and can mean big losses.
- Stay cool and try to keep emotion out of your trades. Don't deviate from your plan.
If you follow these simple guidelines, you may be headed for a sustainable career in day trading.
Day Trading Example
A day trade is exactly the same as any stock trade except that both the purchase of a stock and its sale occur within the same day, and sometimes within seconds of each other.
For example, say a day trader has completed a technical analysis of a company called Intuitive Sciences Inc. (ISI). The analysis indicates that this stock, which is listed in the Nasdaq 100, shows a pattern of rising in price by at least 0.6% on most of the days when the NASDAQ is up more than 0.4%. The trader has reason to believe that this is going to be one of those days.
The trader buys 1,000 shares of ISI when the market opens, then waits until ISI reaches a particular price point, probably up 0.6%. The trader then immediately sells the entire holding in ISI.
This is a day trade. Obviously, the merits of ISI as an investment have nothing to do with the day trader's actions. A trend is being exploited.
What if ISI had bucked the trend and lost 0.8%? The trader will sell anyway and take the loss.
How Do I Get Started Day Trading?
A successful day trader understands the discipline of technical analysis. This is identifying trading opportunities by observing and plotting the patterns of price and volume movement in a stock (or any other investment). The long-term trend shows how the stock has behaved in the past and suggests how it should behave in the immediate future.
Technical analysis is not usually done with paper and pencil these days. There are software packages that help create charts and graphs for the purpose.
The day trader also must have a plan in place before making a single trade. Which stocks to trade and what price points are acceptable for buying and selling all must be set in advance. A successful day trader does not leave room for impulse purchases.
Finally, even a solo day trader must have a trading desk, fully equipped with the news services, real-time data, and brokerage services needed to carry out the plan.
If you're going to trade on margin you'll also need a lot of cash on deposit with the broker. This is not recommended for a beginner as it carries a high risk that the trader will wind up broke and deep in debt.
Much better to start out with whatever amount of cash you can afford to lose.
What Is the First Rule of Day Trading?
The first rule of day trading is never to hold onto a position when the market closes for the day. Win or lose, sell out.
Most day traders make it a rule never to hold a losing position overnight in the hope that part or all of the losses can be recouped.
For one thing, brokers have higher margin requirements for overnight trades, and that means additional capital is required.
There's a good reason for that. A stock can go down or up on overnight news, inflicting a bigger trading loss on the owners of shares.
What Are the Margin Requirements for Day Traders?
According to the Financial Industry Regulatory Authority (FINRA) rules, the minimum equity requirement for a client of a broker-dealer who is designated as a pattern day trader is $25,000. This must be deposited into the client’s account prior to any day-trading activities and maintained at all times.
What Is Day Trading’s Buying Power?
Buying power refers to the total funds that an investor has available to trade securities, and it equals cash held in the account plus the available margin.
According to FINRA rules, a broker-dealer client who is designated as a pattern day trader may trade up to four times their maintenance margin excess as of the previous day’s market close.
The Bottom Line
Day traders can earn big profits or pile up big losses. It's an extremely risky career choice.
Day traders, both institutional and individual, would argue that they play an important role in the marketplace by keeping the markets efficient and liquid.
Though day trading will always be intriguing to individual investors, anyone considering it needs to acquire the knowledge, the resources, and the cash that it takes to have a chance at succeeding.
U.S. Securities and Exchange Commission. "Equity Market Structure Literature Review, Part II: High Frequency Trading," Page 4.
Dummies. "A Day in the Life of a Day Trader."
Business Insider. “If You’re Day Trading, You Will Probably Lose Money: Here’s Why.”
Wall Street Prep. "Sales & Trading Analyst: Day In The Life."
U.S. Securities and Exchange Commission. “Day Trading: Your Dollars at Risk.”
Forbes. “Day Trading: Smart or Stupid?”
U.S. Securities and Exchange Commission. “Margin Rules for Day Trading.”
Day Trading: The Basics and How to Get Started
Day Trader: Definition, Techniques, Strategies, and Risks
Is Day Trading Profitable? How to Get Started
Stocks: What They Are, Main Types, How They Differ From Bonds
Getting Acquainted With Options Trading
Forex (FX): Definition, How to Trade Currencies, and Examples
Best Day Trading Platforms
What Is a Trading Platform? Definition, Examples, and Features
Choosing the Right Day-Trading Software
The Complete Guide to Choosing an Online Stock Broker
Using Paper Trading to Practice Day Trading
Market Order: Definition, Example, Vs. Limit Order
What Is a Limit Order in Trading, and How Does It Work?
Stop Order: Definition, Types, and When to Place
10 Day Trading Tips for Beginners
How to Choose Stocks for Day Trading
Top 10 Rules For Successful Trading
Short Selling: Definition, Pros, Cons, and Examples
A Guide to Day Trading on Margin
Market Risk Definition: How to Deal with Systematic Risk
Risk Management Techniques for Active Traders
Risk/Reward Ratio: What It Is, How Stock Investors Use It
Trading Psychology: Definition, Examples, Importance in Investing
The Importance of Trading Psychology