Day Trader

who close all of their trading positions before the end of the day by executing a relatively large volume of short and long trades.

Day traders close all their trading positions before the end of the day by executing a relatively large volume of short and long trades. They aim to maximize their profit by capturing short-term price movements.

This is a fundamental distinction in contrast to those holding positions overnight, which is a standard practice among investors. Instead, traders will purchase securities, hold them for some time, and then sell them at a higher price when they believe the price will be able to go up in the future. 

They will also buy securities during low-volatility periods and sell them during high-volatility periods as they try to make money on their investments. This strategy relies on timing the market right and carries a lot of risk for inexperienced traders.

The most common day-traded instruments are

What is Day Trading?

Day trading is an investment strategy that involves purchasing and selling securities within a trading day. A day trader can hold his position from seconds to hours but will generally close it before the end of the day. This strategy can be hazardous, and the investor could lose their entire investment if executed incorrectly.

They typically seek to buy stocks at lower prices and then sell them at higher prices to cash a profit; however, to gain profit, traders can do the exact opposite, which is trading at a high price and buying at a lower price to profit from the difference.

A trader might also use this strategy to hedge against other investments, such as bonds or commodities.

For example, suppose an investor's long-term portfolio consists of Apple stock and the market crashes. They can hedge this position by selling Apple stock, building different parts, or buying put options

One key thing to remember about day trading is that it is considered speculation rather than investment because you do not hold the investments over a given period.

That is why day trading is risky, short-term volatility is far greater than longer-term, and thus they are more exposed to significant losses than value-oriented investors.

The reason behind Day trade

They will typically buy many shares at a low price and sell them for a higher price before the market has closed. They usually trade with significant capital or use margin accounts. The more capital you put in, the more risk you incur.

Even a tiny 1% movement can give you a profit/loss of $1,000. However, when your account shows such huge losses, it can break you down emotionally. Hence, day trading is not easy, requiring a lot of dedication, experience, and patience to profit from the market.

Suppose that the day trader does not have such huge capital. So what should he do then? Such traders use margin accounts to open trading positions with brokers using small capital and take prominent roles in volatile stock exchanges.

Let's assume that if you have $1,000, your broker allows you a leverage/margin of 100 to 1. You can buy positions worth $100,000 and profit based on the market scenario. But the potential risk also increases with magnified leverage used in margin accounts.

For example, after buying $100,000 worth of position, if you make a loss of $1000, you will lose the entire capital in the trading account. Any more losses and you will be required to comply with the margin calls by adding additional funds to your account. 

A trader can also purchase shares during non-volatile periods of the market, seeking not to lose money on their investments, and then sell those securities when the volatility increases.

NOTE

Given a certain number of trades, a trader may open on a given day, and only a tiny percentage of them is likely to yield any profits.

Pattern Day Trader (PDT)

Any trader who executes four or more day trades over five trading days using a margin account falls under the regulatory surveillance of pattern day trading. To avoid excessive trading by investors, the brokers put up this surveillance to reduce the risk associated with day trading.

Per the rule, they must hold $25,000 in their margin accounts. Then, for any margin calls, the trader must answer them within five business days by bringing the balance up for their margin account.

If the trader fails to comply with the rule, his margin account will be changed to a cash-restricted account for 90 days or until the issue is resolved.

For example, if Joseph has $50,000 in his trading account, he can buy stocks worth $200,000(4x leverage) to use in his day trading strategies. As a result, he would earn a profit of $2,000 even if the stock gained 1%. However, the potential losses are amplified by the fact that if the stock drops by 3%, it results in a loss of $6,000.

However, for open positions with more than a 20% loss ($40,000), he would receive margin calls to maintain the minimum balance in the account. The restricted account returns to normal by depositing more than $15,000. 

The Risks of Day Trading

The risks that come with day trading are not the same for all individuals. Some day traders with a good strategy can build up enough capital to be set for life. However, some investors will run into trouble if they're not careful.

For example, if you day trade without a plan, you might take on more risk than you are comfortable with. This could lead to over-leveraging, resulting in more significant losses in the future.

You should always ensure that your trades are calculated based on factors you can predict before making them ensure success.

They should be aware that the risks of day trading include the following:

  • They have to pay much higher commissions than investing in securities over a long period. They incur higher taxes -especially when they earn a profit, which 

  • Lack of diversification - A long-term investor can build his portfolio by investing in different sectors increased risk of getting "stopped out" due to high volatility periods - To mitigate these risks, we have to employ a solid strategy.
    For example, to avoid being "stopped out," they should use a stop-loss order, an order placed with a broker to sell an investment at a specific price point before the market reaches its breaking point.

 As day trading is risky, the US Securities and Exchange Commission has made several warnings to investors about it in depth here.

How to Know When to Sell and When to Buy in the Stock Market

Investing in the stock market can be a great way to make money. But it's not as easy as you might think. One of the investors' most common mistakes is buying at the wrong time and selling too quickly.

There are two types of day traders:

  • those who prefer to work alone, and
  • those who work for hedge funds and financial institutions.

The latter's advantage is that they have access to a wide variety of resources, such as significant trading capital, analytical software, and research teams. However, if you are working alone, you must have in-depth knowledge of the marketplace.

With knowledge and experience comes the intuition of when is the right time to buy and sell in the stock market. Another critical parameter while trading is discipline. Learn all the profitable strategies you like, but you will lose your money without proper discipline.   

To earn money, you need to set a goal and be realistic about your timeframe. For example, most prefer a timeframe of 1 or 3 mins for trading and 15 minutes to understand the overall market sentiment while reading the charts.

They look for high volatility periods to purchase low-price securities and sell them at a higher price not to lose money on their investments. This can be successful if done correctly, but it's risky for individual traders.

Several factors impact the price of a security to know when you should buy or sell a stock:

  • market sentiment,
  • macroeconomic conditions,
  • investor behavior,
  • news headlines,
  • earnings reports, etc.

Therefore, you must evaluate all these factors before deciding whether a security is going up in value.

Day trading strategies

We will discuss some of the different strategies in this section.

The day trader can use several trading strategies to maximize their profits:

1. Scalping

Scalping is a trading strategy that requires the most precision as it involves taking 10 to hundreds of trades in a single day based on minor price changes in stock price. The general belief by scalpers is that small profits will compound significant gains if a strict stop loss is maintained in the trading strategy to avoid substantial losses.

In addition, arbitrage opportunities might exist, i.e., simultaneous buying and selling of the same asset in different markets to profit from the bid-ask price difference.

For example, assume you buy ABC company on the New York Stock Exchange for $30.44 and sell it on London Stock Exchange for $30.55. 

2. Range-based trading

This trading strategy is based on identifying support and resistance zones in the stock charts. In addition, stock trading in channels or patterns such as triangles, heads & Shoulders can qualify for range-based trading.

Horizontal trend lines are drawn after finding the significant support and resistance zones, and positions are initiated if the stock trades at either support (buy the stock) or resistance zones (sell the stock). 

3. News-based trading

A trader who buys or sells stocks based on breaking news, economic reports, and other important news that affects the nation use a news-based trading strategy. Any breaking news can potentially increase the market volatility and provide a profit-making situation if a trade is initiated with a proper risk: reward ratio with strict stop loss.

4. High-frequency trading

The better half of scalping, high-frequency trading, uses powerful computers that trade on the exchange using complex algorithms expert in analyzing market conditions and executing trading positions at a faster speed.

Generally, the trader with a quicker trade execution speed is the one who makes more profit and comes out of the market unscathed.

Advantages and disadvantages of day trading

The benefits of day trading are that it is a quick way to make money if done correctly. Individuals can quickly make a lot of money and do it from their homes. They also can diversify their portfolio because they invest in various securities at different times.

However, there are disadvantages to this type of trading too. For example, day traders may get caught up in the excitement and buy securities that will not end up going higher or sell securities that will go down in value despite being told otherwise, which could lead to personal losses.

This type of trading requires much more research and dedication than traditional investing because trades need to be made quickly, and day traders need to monitor the market all day long constantly.

Should you start day trading?

Day trading can be quite challenging for anyone new to the trading world. It is a matter of preference for every individual. Some prefer to invest in stocks, while others look to safer places like mutual funds.

Charts

Time is a crucial constraint for anyone looking to start their career as a day trader. Therefore, we have listed some pointers to guide you in becoming a day trader.

  • Firstly, you need knowledge about investing in the stock market and a good idea about risk management, brokerage & taxes, capital, etc.

  • Spend a lot of time studying charts and perfecting your strategies. Then, make dummy paper trades to track the success ratio of your trading strategies.

  • Focus on only a few stocks that offer the most significant volatility in market conditions. It helps you distract from the market's unnecessary noise and ultimately avoid substantial losses.

  • Control your emotions when you are on the losing side. Know that the market is supreme and accept 'small' losses. Revenge trading will wipe out your entire capital.

  • Trading is like a flowing river; swimming along with its current is better than against it. That means if the market is down, don't make unnecessary long positions believing that the market might rebound by the end of the day. You will only end up losing a big chunk of capital.

Check out the video below that gives an insight into the life of a day trader.

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