Day Trading – Everything You Need to Know

If you are good at it, day trading can be very lucrative. You can generate an income or grow capital with a relatively small account. It can be very exciting too if you have the right temperament. And that’s the secret to day trading – it suits a certain type of personality. What follows is an introduction to day trading and some tips for deciding whether it may be right for you.

What is Day Trading?

The simple definition of a day trade is a trade that is opened and closed on the same day. Day traders have no positions when they log off at the end of the day and don’t have to worry about overnight moves.

Some day traders hold positions for very short periods of time – minutes or even seconds. Others will hold a trade until it either hits a profit target or a stop loss level. And, others hold their position until just before the market closes if it is ‘in the money.’

The time constraints of day trading mean you only buy or sell an instrument if you are fairly certain it will do what you think it will do before the end of the day. This means supply and demand are the most important characteristics of a market. Fundamental analysis is of limited value to day traders, and most use some form of technical analysis or ‘tape reading.’

Day traders have to know their chosen markets intimately and understand who the different players in the market are, how they are positioned, and how they are likely to react to price movements.

Markets for Day Trading

Day trading is only viable in liquid markets that are relatively cheap to trade. That means low commission rates, and tight spreads. The availability of margined accounts or leveraged instruments like futures is also necessary.  These are the popular markets for day traders:

Stocks

If you are going to day trade stocks, half the battle is deciding which stocks to trade. The average stock simply doesn’t move enough each day to warrant trading intraday. Those who day trade stocks tend to specialize in one of three groups of stocks.

Firstly, there are the stocks that are very liquid and reasonably volatile on most days. These are stocks of companies like Amazon and Tesla that are traded by thousands of day traders every day, which adds to the volatility and liquidity.

Secondly, some traders specialize in ‘in play’ stocks. A stock is in play when it is the subject of speculation and news, or during the days either side of its earnings release. A stock may be in play for a few days after a news release, or for months at a time if it is the target of a takeover or the subject of an ongoing story.

The third group, penny stocks, wouldn’t usually qualify as day trading candidates due to their low liquidity. However, penny stocks can experience explosive intraday moves when the conditions are right. Day trading penny stocks is very risky, but some traders do seem to get it right.

Equity indices

Index futures have been a staple market for day traders since they were introduced in the 1970s. The most popular indexes are the S&P500, FTSE 100 and DAX 30. Futures markets typically have longer trading days, with the S&P500 trading nearly 24 hours a day.

Headline indexes are a barometer for the overall market and used to hedge equity positions and speculate on the next move by the largest funds and institutions in the world. Future markets often move before any other market when major events occur. Trading index future means you need to know exactly what is driving the market on a given day and be alert to anything new hitting the market.

Forex

The global currency market is the largest in the world, which means it's also the most liquid. Day trading forex is more popular outside the US due to the fact that it tightly regulated in America and quite loosely regulated elsewhere.

Some day traders do trade forex successfully, but a lot of forex traders prefer slightly longer timeframes. The big difference between forex and other markets is that forex markets are open around the clock. However, different currencies are more active at different times of the day, so day traders need to decide on their preferred currency pairs and the time of day they will trade.

Forex trading requires a good understanding of both charts and economics – in particular, interest rates and what affects them.

Cryptocurrencies (Also known as Digital Assets)

The newest day trading market is the cryptocurrency market. Because the market is still in its infancy, liquidity and volatility are forever changing, and the digital currencies that are suitable for day trading are forever changing.

This means anyone trading cryptocurrencies must remain up to date with the crypto market, the most liquid coins and what drives their price and volume.

Commodities

Some day traders specialize in trading commodities – usually oil, gas, gold and silver. These markets are also day traded by traders who trade other futures markets.

Trading commodities on an intraday basis requires a lot of domain knowledge. You have to understand the charts, the industries and all the different players in the market. Each market has a lot of nuances that affect the way the underlying market trades, as well as its futures market.

Day Trading Strategies

Most successful day traders develop their own unique method of analyzing and trading their chosen market. To develop their method they typically adapt one or more of the strategies listed below. In many cases these strategies overlap one another – and in almost all cases charts are the most important tool.

Trend following

Trend following is a very successful approach when the daily range is wide enough or if it is expanding during periods of volatility. Trend follower use trendlines, moving averages or similar indicators to identify new trends. A trend following strategy is typically very systematic and based on a set of rules.

Momentum

Momentum traders identify patterns that signify increasing momentum in the direction of a trend. They hold positions for as long as the momentum continues, often using a trailing stop loss to lock in profits.

Chart patterns

Some of the classic chart patterns that traders use on daily and weekly chart patterns can also be used to trade intraday. Chart patterns have specific price targets and positions are closed when the target is hit. Candlestick patterns are also commonly used by day traders, especially in the forex market.

A lot of day traders also favor Elliott Wave chart patterns – though this approach takes some time to learn.

Mean reversion and range trading

When a market trades in a clearly defined trading range, or in a trend channel, the trading range can be traded. This means shorting the market when the price is at the top of the range and buying when it’s at the bottom of the range.

Reversals

Reversals can occur within a trading range or when a trend changes direction. Traders use patterns and indicators to identify potential reversals and profit targets. Under the right market conditions, reversals can be very profitable for short term traders.

Scalping

Scalpers identify momentary imbalances in supply and demand to catch quick price changes before taking profits and moving on to the next trade. Scalpers sometimes execute 20 or more trades in a day.

News trading

Prices often move substantially after economic or company news is released. Corporate news is often released before or after the trading session, so opportunities for stock trades are limited. However, economic news is scheduled, and forex and index traders can trade ahead of, or after, data is released.

Is Day Trading Right for You?

While some people thrive at day trading it isn’t for everyone. It suits certain personality traits more than others. Some of the traits of a good day trader apply to most types of trading—but when it comes to day trading they are even more essential.

For a start, you need to be able to stay focused and watch the market all day. If you are easily distracted or are likely to get bored on slow days, you will miss crucial opportunities.

To maintain focus and motivation, it helps if you are actually fascinated by markets. This includes being interested in economics, business, psychology and game theory. Curiosity and an eagerness to learn will also help with idea generation.

Next up is discipline. You need to be very disciplined to succeed at day trading. This applies to sticking to a risk management framework, and to looking after your health and doing pre-market preparation every single day.

You will need to have resilience to keep going when things don’t go your way. Day trading can be very frustrating and there will be days when you will want to walk away from it. Every successful day trader has been through periods of self-doubt and managed to keep going.

The ability to adapt often separates the best day traders from those who struggle. Markets change, and traders need to keep adapting to different market conditions, and sometimes to entirely new markets.

Day trading is not a hobby. To become successful requires time and hard work. You need to be prepared to devote 8 to 10 hours a day to it and to treat it like a business, which is exactly what it is.

Pros and Cons of Day Trading

Like most things in life, day trading has its advantages and its drawbacks.

Advantages of Day Trading

• Day traders get to participate in all the up and down moves that make up the long-term price movements. Between 2010 and 2020 the S&P500 index returned around 13% a year. However, over the same period, the average daily move was around 0.7%, which adds up to 175% a year. Day traders get to trade all those daily moves.
• Day trading is a very efficient way to use capital. You get to move capital from one opportunity to the next multiple times a day.
• It’s also a good way to use leverage with favorable reward to risk ratios. Because stop losses are tight, you risk a relatively small amount for a limited period each day, with the potential for much larger rewards.
• Because positions are closed each day, you do not have to worry about overnight moves.

Disadvantages of Day Trading

• Day trader’s profits are usually taxed as income, not as capital gains, and therefore pay a higher rate.
• Day trading can be incredibly stressful and exhausting at times. It’s especially important to manage stress and take time off when necessary. It’s also essential to exercise, eat well, and get enough sleep.

What do You Need to Begin Day Trading?

So, what do you need to start day trading? The first thing you need is time. Day trading is a full-time profession, and you will need to be in a position to give it enough time. There is some flexibility here though. It is possible to trade just the opening or closing session each day – as long as it’s the same session each day. You will need to find a strategy with a very short time horizon and will miss out on some of the bigger moves. Overall, you won’t be able to earn as much and it will take longer to learn – but it can be done.

The second requirement is capital. Any stock trader who executes four or more day trades a week using a margin account is classified as a day trader by FINRA. That means their account balance must remain above $25,000. So, for stock traders, $25,000 is the minimum to get started. Theoretically, you can day trade futures with as little as $1,000 – but most brokers will require you to have a larger account. Ideally, you should have at least $20,000 regardless of the market you trade.

You will also need capital or some form of regular income to live on until you are consistently earning an income from the market. There is no specific amount – but the more you start with the more chance you will have to become profitable.

Of course, you will need a broker too. The broker will depend on the market you choose to trade. It’s always best to choose a broker that specializes in the market you intend to trade. Beyond that, there are plenty of resources to research brokers.

Day traders need trading platforms that are fast, reliable, and have a range of technical analysis tools. Fortunately, most brokers provide great platforms for their clients to trade on. You will however need a good PC with an extra screen—you don’t need a bank of monitors, but one extra monitor helps. You will also need a reliable internet connection and a backup connection in case your line goes down.

How to get started

To get started you should begin learning about markets and strategies. Read as much as you can about different markets and start following them on a day-to-day basis. At the same time, you can start reading more about the diferent trading strategies outlined above. You should begin to get an idea of the markets that interest you, and trading methods that make sense to you. This should put you in a position to start looking for a broker where you can open a demo account and begin paper trading and eventually begin putting real capital to work.