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What Is Day Trading?

No two investors are the same, but they can be broadly broken down into categories. The fast-paced traders frequently opening positions and closing them before the end of the day are day traders.

Day trading is perhaps the most exciting way to trade. When it’s done well, it can be quite lucrative, too. As opposed to traditional buy-and-hold investors, who buy shares with the intention of holding them for decades, day traders make quick plays off the day’s movements. Each of these trades invites the opportunity for profit—as well as loss.

If you’re considering a trial run at day trading, keep reading for an overview of the concept, along with some of the benefits and risks.

Day Trading 101

Day trading is much more complex than standard investing. Newcomers, even those with some basic trading experience, will no doubt encounter a slew of new terms, acronyms, and trading strategies. Here are some of the most important terms to understand as you dip your toes into the day trading waters.

Pattern Day Trading: A pattern day trader is a person who opens and closes a position on the same day at least four times per week. You may be asking yourself, “how much difference is there really between three trades a week and four?” The difference is a legal distinction. The U.S. government requires that pattern day traders maintain an account equity balance of at least $25,000. If you make fewer than four day trades per week, then you can avoid this requirement.

Beta: A stock’s beta measures its relative volatility compared to the overall stock market. Day traders seek volatility, and beta can help them find it. If the stock has a beta below one, that means it’s relatively less volatile than the benchmark index. If the beta is more than one, then the stock is relatively more volatile.

Resistance/Support: Resistance refers to the price at which the stock can’t seem to push past in recent trading sessions. Support refers to the opposite—the price at which the stock can’t seem to drop below. The definition of “recent” varies from trader to trader. Some prefer to use a five-day moving average, others use 10-day (or more) averages. By tracking a stock’s price relative to its support and resistance levels, day traders can plan their trades.

Gaps: Sometimes major news about a company breaks after hours or over the weekend. The news could be good or bad, but if it’s significant enough, you can expect to see the stock make a major jump as soon as the markets reopen. When a stock opens much higher than the previous day’s close, that’s known as a gap up. When the stock opens much lower, it’s known as a gap down. Either way, it could present an opportunity for day traders to “play the gap” as the stock moves from its opening gap back to its normal trading pattern.

Trade Trigger: Successful day traders stick to their plans, which are established well before they start adding positions to their portfolio. Trade triggers are a key piece of these plans. Trade triggers refer to the pre-determined indicators that trading should happen. The most fundamental trade triggers are entry points (when you buy a stock) and profit targets (when you sell a stock). You should also establish a trade trigger for when to cut your losses and get out of a bad trade (stop-loss).

Leverage: Pattern day traders use margin accounts to increase their buying power. Margin accounts allow traders to borrow money from a brokerage to buy stock. You may also hear this referred to as “buying on margin.” The money that you’re able to borrow to buy securities is known as your leverage. Pattern day traders have access to more leverage than regular investors, but they need to ensure that their leverage (their borrowed funds) remains in an appropriate ratio to their equity (the amount of cash they have access to if they close all their positions).

Is Day Trading Risky?

All forms of investing carry some level of risk. Day trading is no exception. In fact, depending on your level of experience with stock markets, day trading could be among the riskiest strategies to try.

Day traders need to understand common stock movement patterns. They need to know how to predict these patterns through the use of detailed graphs and metrics. If you’re just learning the difference between a bid and an ask, stick with standard stock trading while you hit the books. With an intimate understanding of market patterns and tools, the risk begins to fade away, but some level of risk will always remain. Carefully planning your trade triggers and stop-loss orders can further reduce your risk.

Risk also varies by a day trader’s chosen strategy. Trading on expectations of how a news event will affect a company carries a moderate amount of risk. For those who have access to advanced software that uses algorithms to automatically capitalize on arbitrage trading opportunities, there’s significantly less risk. The amount of leverage a trader uses also increases the risk.

Day Trading Benefits

Experienced day traders enjoy many benefits over their buy-and-hold counterparts. If you can master basic day trading strategies and limit your risk, then these are some of the ways you can expect to be better off.

Better News-Based Trading: If you’re a news junkie who wants to turn your passion for current events into profit, you may be able to accomplish this better as a day trader. The impact of news on the markets is typically the most drastic just after the news breaks, so day traders are better poised to take full advantage of news trading than traders who hold positions overnight or longer.

Any Movement Is Good Movement: Volatility is terrifying for most investors. When markets start swinging wildly, as they did once the 2020 COVID-19 epidemic transitioned into a full-blown pandemic, buy-and-hold investors worry about when it’s safe to re-enter the market and start buying stocks again. Day traders don’t have to worry about this, and in fact, that volatility is a good thing. Day traders can make money by trading any kind of movement, whether it’s positive or negative. So, while buy-and-hold investors sat it out and waited for the markets to stabilize, day traders made a killing.

Realizing Gains Every Day: Buy-and-hold investors wait years, sometimes decades, before they can cash in on their investments. They can watch their account equity grow, but those aren’t actually dollars they can withdraw and spend at the store. Day traders, on the other hand, close out all their positions by the end of the day. That means they’ve got cash in hand at the start and end of every day, while buy-and-hold investors just have shares.

No After-Hours Risk: Another benefit of closing out positions before the day’s close is that you aren’t exposing yourself to after-hours risks. This can be especially beneficial during quarterly earnings seasons. Stock prices typically move significantly after a company releases its earnings report, so companies reveal this information after the stock market closes. If the report is disappointing, anyone holding the stock will likely suffer a gap down at the next day’s open, but day traders who closed their position won’t be impacted by the sudden price movement.

Greater Leverage (Potentially) Means Greater Profit: Day traders can borrow up to four times their maintenance margin excess (the equity in their account beyond the minimum established by federal law and your broker). Traders who hold stocks overnight can only borrow up to two times their maintenance margin excess. Buying stocks on margin is risky, but if it’s done correctly, it can result in exponentially greater gains. By having access to twice as much capital through margin loans, day traders can potentially earn far greater profits.

Deep Understanding of the Markets: Knowledge is crucial for day traders looking to turn a profit and reduce their risk. However, the knowledge required for day trading is useful for all manners of investment. Even if you decide day trading isn’t for you, learning the strategies behind a day trade will help you in all market matters. You can learn about day trading without taking the risk by using a trading simulator.

How To Be a Successful Day Trader

The most obvious traits of successful day traders are knowledge and capital. As mentioned above, a deep understanding of the markets is crucial to day trading. You also need to have a lot of spare cash. The best day traders only trade with extra money—not their retirement savings. To be a pattern day trader, that means you need an extra $25,000 to play with at the absolute minimum.

Day traders are also aggressive traders who don’t mind taking on big risks in search of even bigger rewards. Leverage is one of the key advantages to pattern day trading, and if you aren’t using that leverage, you aren’t day trading to your fullest potential. Not everyone should feel comfortable taking on such high levels of risk, but those who do are best-suited for day trading.

Not only should you feel comfortable with risk, but you should also be unflappable while taking on these positions. The best day traders are cold, disciplined, and utterly unemotional while trading. Emotions get in the way when you’re facing a string of losses, for example.

Emotions don’t just come into play when things are going bad. If you’ve hit your profit target but the stock is still skyrocketing, your emotions may urge you to hang on and ride the momentum. If you don’t have the discipline to check your emotions and stick to the plan, then you don’t have what it takes to be a day trader.

Day traders also need the discipline to stick to a strict trading schedule. If you have a full-time job, it might be tough to break into day trading, just because of the time requirements. The best day traders spend at least a few hours per day checking in on the market. It’s not like you can check in on the market on your own schedule, either, you need to trade during market hours. You also need to space out your check-in times so that you’re following the market throughout the day, rather than just following a three-hour chunk of trading activity.

While knowledge is important for day trading, you need the right software to use that knowledge to its fullest. That means finding a stock screener that’s both intuitive and in-depth. Advanced day traders seek out high-end software that uses neural networks and genetic algorithms to predict stock movement. Keep in mind that you get what you pay for—if you’re using the free version of a stock screener, you probably won’t be able to compete with other day traders.

When in Doubt, Practice Makes Perfect

While the pros have an arsenal of tools to minimize their risk, beginners expose themselves to significant risk when they’re starting to experiment with day trading. If you want to try day trading, but you know it isn’t wise to open yourself up to that kind of risk yet, practice with a trading simulator.

To start day trading, you can use a simulator that lets traders act like they’re playing the market without risking a penny. It’s highly recommended that people use this feature before diving head-first into day trading. Once you rack up a significant winning streak of day trades, take your strategy into the real world by opening a margin account.