The thing about stocks, foreign currencies, derivatives, and other financial instruments is that their value changes – sometimes gradually, sometimes dramatically, but certainly all the time. Successful day traders aim to maximise the profit they earn from small changes in the price of whatever they are trading, as these fluctuations happen. These pretty much take place over the course of hours, meaning that day trading can be a full-time job. Someone investing for their retirement generally takes a very different approach, perhaps focusing on buying undervalued assets or those most likely to show future growth.
Defining day trading
Day trading refers to the practice of buying financial instruments with the intention of selling them again before the market closes. Traders who engage in day trading are, quite reasonably, known as “day traders”. This profession or investment approach is, however, different from “scalpers” or high-frequency traders, who operate on an even shorter timeframe.
This difference is not only defined by how often someone trades. Scalping is a very active form of investing and scalpers open and close many trades per day. A day trader, by contrast, takes a more sedate approach and might not trade every day. When they identify a promising opportunity, however, they expect to profit from it in only a single trading session.
Swing traders are next up in this spectrum of classification and will usually hold trades for multiple days or weeks. Position traders trade the least frequently: once in a trade, they often sit on it for months, waiting for the price trend to move in their favour.
How to be a day trader
To be successful at the day trading game, one needs three things:
- Knowlege
- Experience
- A certain mindset
These requirements probably sound familiar: many people will tell you that they are what you need to perform at a high level in anything. The clearest examples of how exactly these apply to success in day trading come from sport.
Esteban Ocon, the French Formula 1 Racing driver, is famous for his strong finishes for the Alpine racing team. Peter Sagan, the world-renowned Slovak cyclist, is a multiple-time world champion. It’s not hard to think of day-trading personality archetypes competing in any other game you can name: in each case, their performance is partly dependent on consistent concentration, constant training, a broad and deep understanding of their sport, and the ability to learn from and continue after a loss.
These racers must stay focused through every corner and are ready to strike when there is an opportunity to overtake. Day trading requires a similar perspective: mistakes are easy to make and often disastrous. A day trader must follow the market action and be aware of every turn in the price action, so that they are ready to place a trade when the opportunity arises before it quickly disappears.
How to day trade
Since no one can keep an eye on the entire market, day traders rely heavily on only a few assets, opening their positions on the market throughout a trading day and usually closing them before the trading day ends. There are a number of ways for them to decide what is worth buying:
1. Following the latest economic news and events is of utmost importance to a day trader. Announcements of new economic data and politicians’ comments help paint a picture of how a specific asset will perform over the coming day, especially when unexpected news makes the market overshoot.
2. Technical analysis is also central to carrying out a successful day trading strategy. Using a variety of indicators, investors can evaluate the mood and direction of markets and thus gain an idea of how a given asset may move, how strong that price movement may be, and how long it could last. Combining technical and fundamental analysis and perhaps paying a premium for this information gives experienced investors an edge over others when day trading.
3. Using leverage on trading platforms is also key to many day trade ideas, as this enables investors to control larger positions on the market with a smaller initial investment. As the price movements can often be small, leverage is used to magnify profits.
The last point applies equally well to losses: a mistimed or misjudged leverage trade can potentially sink the best day trading strategy if it does not also take account of risk management practices.
Day trading strategies
Learning day trading basics starts with choosing one of the major categories of trading strategies. Digging down into the details of each system, instead of trying to become a generalist overnight, gives your an edge over other less-experienced traders. There are three types of day-trading strategies to consider:
1. Trend trading
Whatever trading platform you use, viewing an asset’s price in chart view should provide some information on possible trends. Trend trading involves studying these indicators over a longer timeframe to identify the prevailing market trend: up, down, or sideways. Once one has been ascertained, an investor will revert to a smaller timeframe view on the same price chart and look for trading opportunities that follow the trend shown over a longer period.
For example, if the EUR/USD currency pair is trending upwards on the 4-hour time frame, then a trend-oriented day trader can switch to a short-period market session of 15-minutes and look for moments to go long on the pair in the same trading day.
2. Counter-trend trading
Similar to trend trading, this day trading style involves identifying a prevailing market trend on a longer time frame and then looking for opportunities to place trades, but in the opposite direction at a shorter time frame. The idea behind this is to try to identify where a market trend is likely to end and profit from the reversal. This is a riskier strategy than ordinary trend-following investing, but it can lead to greater profits for someone who carries out accurate market research.
For example, if Apple shares (AAPL) are in an upward trend that seems to be slowing on the 4-hour time frame, a counter-pattern day trader can look for opportunities to short the stock on the 15-minute time frame to benefit from a potential reversal in the stock price.
3. Breakout trading
Breakout trading means to recognise when an asset has entered a period of consolidation; in other words, trading in a range between support and resistance levels that have been holding strong. The question breakout traders ask themselves is: when will this change?
Swing and day traders will then take positions on either side of the range, in the hopes that the asset will break out and start following a new trend. This day trading strategy is usually more effective when an asset’s price has been trading within a very tight range. Investors generally target profits equal to the earlier trading range and place trades immediately.
The problems with day trading
Day trading sounds simple enough in theory, but it’s certainly not for everyone. There are a number of factors that affect the potential profitability of the day-trading approach and retail traders should take these into consideration before proceeding with such a strategy.
1. Required capital to day trade
Being undercapitalised is one of the main reasons traders struggle to thrive in the market. A day-trading account must be sufficiently funded to protect an investor’s open positions in the case of market volatility – if not, you may be forced to sell before an asset’s price turns in your favour. How much capital you have deposited with your broker or online trading platform becomes even more important when it comes to day trading, where positions are left open throughout a trading day.
Additionally, the use of high leverage levels with an undercapitalised account can lead to added risks, up to and including the loss of all invested capital. Take a look at the rules drafted by the financial industry regulatory authority: they do not always protect the stupid or poor. Sometimes, making a margin call can save you. This type of call is triggered when a trader’s brokerage balance drops below the minimum equity amount permitted by margin requirements.
Furthermore, you need to be careful of instruments such as penny stocks and options and make use of traditional stocks, as these are more secure. As in long-term investing, some level of diversification is key.
2. Transaction costs
As day trading can involve opening and closing a number of trades within a single day on an online trading platform, transaction costs for each trade must be taken into account when formulating a strategy. Both spreads and commissions are calculated on a per-trade basis, meaning that the more trades an investor makes, the more costs they will accrue.
Thus, a successful day trading technique is going to be one in which an investor is able to earn enough from trades throughout the day to both cover the costs involved and make a profit on risking their own capital.
3. Day trading psychology
Trading psychology is of utmost importance when it comes to investing in the financial markets, but rarely more so than in the case of day trading. There are added pressures day traders must consider, as large trades may be placed quickly and must be monitored throughout the day. As such, being successful requires a great deal of preparation, tracing past performance and determination, as well as a sound risk management strategy to protect investors against potential market volatility.
