What is day trading?

Day trading is the buying and selling of securities within the same day to achieve short-term profit. Day trading involves detailed analysis of market trends and carries significant risks.

How does day trading work?

When individuals buy and sell securities within the same day to realize a profit or a loss, they are engaging in day trading. The goal of the day trader is to take advantage of short-term price fluctuations of the traded assets. Someone might buy a stock and sell it on the same day to make a profit, which counts as one day trade.

Note: Sudden price fluctuations during the day can lead to substantial losses for day traders. These losses can compound, and one can lose more than what they initially invested in a security if the trade was made using leverage.

Day trading and trading rules

If investors regularly buy and sell stocks within the same day, they may be designated as day traders by the investment firm they work with. A typical day trader is someone who executes four or more day trades within five days, representing more than 6% of their total trades.

Financial firms are required to designate investors as day traders if they meet this definition or if the firm has a reasonable basis for believing that they will engage in day trading.

Those designated as day traders under FINRA rules must maintain a minimum balance of $25,000 in their margin account. It is nearly impossible to day trade in a cash account.

Example of day trading

Sally is an investor with a brokerage account who trades stocks based on news headlines. Sally carries out the following transactions during the weekdays:

• Monday: Two day trades – bought 25 shares of ABC Computers and then sold all 25 shares – bought 50 shares of XYZ Holdings and then sold all 50 shares
• Tuesday: One day trade – bought 100 shares of 123 Media and sold them on the same day
• Wednesday: Three day trades – bought 50 shares of ABC Computers and sold them all before the end of the day – bought 50 shares of XYZ Holdings and sold them all before the end of the day – bought 50 shares of 123 Media and sold them all before the end of the day

Since Sally made four day trades over five days or less, representing more than 6% of her transactions, she is considered a day trader. Due to this designation, her broker requires her to maintain a minimum balance of $25,000 in her margin account at all times.

However, if Sally had only bought and sold one company each day in the above example, she would not be considered a day trader under FINRA rules. A person can day trade safely but not be classified as a day trader if their trading volume does not exceed the FINRA requirements for day trading.

Day trading in other markets

Stocks are not the only assets that you can day trade. Day traders also trade in the foreign exchange market (also known as Forex) and in futures markets where commodities are primarily traded. Each of these markets operates differently and has its own rules.

Note: The day trader rule does not apply to investors trading currencies in the Forex market.

The minimum balance requirements for day trading in the Forex market depend on the broker managing your account. As a result, investors can place any number of buy and sell trades in their investment account in the foreign exchange market.

Each market has different hours. For example, stocks trade between 9:30 AM and 4 PM, Monday through Friday in the United States, while futures markets and the Forex market trade nearly 24 hours a day for at least five days a week.

Types

Day Trading Strategies

There are many different strategies that investors can implement when day trading. Some strategies focus more on technical indicators, some on news and media, and others use algorithms to buy and sell securities. Some common types of day trading include:

• Momentum Trading: This involves buying and selling securities based on the strength of current price trends. Momentum is often determined by trading volume, volatility, and time frame.
• High-Frequency Trading: This type of trading utilizes programs and algorithms to buy and sell securities within a short time frame, taking advantage of small price changes for profit.
• News-Based Trading: This type of trading conducts daily transactions based on news reports and press releases of the underlying securities.

Some day traders stick to one strategy, while others use multiple strategies to make trading decisions. Remember that your investment bank may also provide tools and access to exclusive reports to help you make timely trading decisions.

Advantages and Disadvantages of Day Trading

Advantages:

• Potential for quick and large profits: Day traders can make several profitable transactions in a single day and often leverage margins for greater returns.
• No overnight position risk: Since day trading is defined as buying and selling securities on the same day, all positions are closed by the end of the trading day, meaning there’s no overnight position risk, such as news updates after hours that could negatively affect your investments, for example.
• Accumulation of profits: Every profitable transaction increases your purchasing power for the next trade, and profits accumulate with each successful trade.

Disadvantages:

• Comes with significant risks: Perhaps the biggest risk associated with day trading is the potential for large losses. Day traders often use leverage, which means they can lose more than their initial investment.
• Can be time-consuming: It may take a lot of time to read chart patterns, momentum indicators, news headlines, etc., to find the right trade. It can take hours in a day to see substantial profits, as most profitable trades are gradual and small in relation to your account balance.
• High balance requirements: A day trader designated as a pattern day trader must maintain a minimum balance of $25,000 in their margin account.
• Taxes: Buying and selling stocks for profit in a short period can have tax implications. Profits from day trading may be subject to short-term capital gains tax, which is taxed as ordinary income.

Day Trading vs. Investing

What Does This Mean for Individual Investors?

Understanding what day trading is allows investors to plan their investment strategies based on the requirements of day trading. Investors who do not wish to impose minimum balance requirements on their accounts should carefully monitor their day trading to stay below the Financial Industry Regulatory Authority requirements for day traders.

Investors with substantial balances and extra time for day trading can achieve gradual and compounding profits when following general day trading strategies. In any case, remember that day trading involves significant risks and the potential to amplify losses beyond the usual.

Questions

Frequently Asked Questions (FAQs)

How do you start day trading?

The first step to day trading is understanding all the risks. After that, you can focus on the market you want to trade in – stocks, commodities, or currencies. Each of these markets operates differently, has different hours, and has different rules. Research the stocks, commodities, or currencies (whichever you wish to trade) and develop your trading strategies. Practice day trading using paper trading or simulation before using your actual money. Get a suitable brokerage account or approvals from your broker. Determine the amount of money you are willing to lose and place your day trading bets.

How do you make money from day trading?

Making money from day trading is not easy. Choosing the right stock, currency, or commodity contract is just the first step in a successful day trading deal. Other factors include determining the amount of money you are trading, the number of trades you make each day, how many trades are profitable, and how many trades result in losses. You will also need to track any fees
Source: https://www.thebalancemoney.com/what-is-day-trading-1031065