Day Trader: Definition, Techniques, Strategies, and Risks (2024)

What Is a Day Trader?

A day traderis a type of trader who executes a relatively large volume of short and long trades to capitalize on intraday market price action. The goal is to profit from very short-termprice movements. Day traders can also useleverageto amplify returns, which can also amplify losses.

While many strategies are employed by day traders, the price action sought after is a result of temporary supply and demand inefficiencies caused due to purchases and sales of the asset. Typically positions are held from periods of milliseconds to hours and are generally closed out before the end of the day so that no risk is held after hours or overnight.

Key Takeaways

  • Day traders are traders who execute intraday strategies to profit off relatively short-lived price changes for a given asset.
  • Day traders employ a wide variety of techniques in order to capitalize on market inefficiencies, often making many trades a day and closing positions before the trading day ends.
  • Day trading is often characterized by technical analysis and requires a high degree of self-discipline and objectivity.
  • Day trading can be a lucrative undertaking, but it also comes with a high degree of risk and uncertainty.

Understanding Day Traders

There is no special qualification required to become a day trader. Instead, day traders are classified based on the frequency of their trading. The Financial Industry Regulatory Authority (FINRA) and U.S. Securities and Exchange Commission classify day traders based on whether they trade four or more times during a five-day span, provided the number of day trades is more than 6% of the customer's total trading activity during that period or the brokerage/investment firm where they have opened an account considers them a day trader.

A day traderoften closes all trades before the end of the tradingday, so as not to hold open positionsovernight. A day trader's effectiveness may be limited by thebid-ask spread, trading commissions, as well as expenses for real-time news feeds and analytics software. Successful day trading requires extensive knowledge and experience. Day traders employ a variety of methods to make trading decisions. Some traders employ computer trading models that use technical analysis to calculate favorable probabilities, while some trade on their instinct.

Day traders are subject to capital and margin maintenance requirements.

A day trader is primarily concerned with the price action characteristics of a stock. This is unlike investors, who use fundamental data to analyze the long-term growth potential of a company to decide whether to buy, sell or hold its stock.

Price volatility and average day range are critical to a day trader. A security must have sufficient price movement for a day trader to achieve a profit. Volume and liquidity are also crucial because entering and exiting trades quickly is vital to capturing small profits per trade. Securities with a small daily range or light daily volume would not be of interest to a day trader.

Pattern Day Trader Designation

A pattern day trader (PDT) is a regulatory designation for those traders or investors that execute four or moreday tradesover the span of five business days using a margin account.

The number of day trades must constitute more than 6% of the margin account's total trade activity during that five-day window. If this occurs, the trader's account will be flagged as a PDT by their broker. The PDT designation places certain restrictions on further trading; this designation is put in place to discourage investors from trading excessively.

Day Trader Techniques

Day traders are attuned to events that cause short-term market moves. Trading the news is a popular technique. Scheduled announcements such as economic statistics, corporate earnings, or interest rates are subject to market expectations and market psychology. Markets react when those expectations are not met or are exceeded, usually with sudden, significant moves, which can benefit day traders.

Another trading method is known as fading the gap at the open. When the opening price shows a gap from the previous day’s close, taking a position in the opposite direction of the gap is known as fading the gap. For days when there is no news or there are no gaps, early in the morning, day traders will take a view on the general direction of the market.

If they expect the market to move up, they would buy securities that exhibit strength when their prices dip. If the market is trending down, they would short securities that exhibit weakness when their prices bounce.

Most independent day traders have short days, working two to five hours per day. Often they will practice making simulated trades for several months before beginning to make live trades. They track their successes and failures versus the market, aiming to learn by experience.

Day Trader Strategies

Day traders use several intraday strategies. These may include:

  • Scalping:this strategy attempts to make numerous small profits on small price changes throughout the day, and may also include identifying short-lived arbitrage opportunities.
  • Range trading: this strategy primarily uses support and resistance levels to determine buy and sell decisions. This trading style may also go by the name swing trading if positions are held for weeks rather than hours or days.
  • News-based trading: this strategy typically seizes trading opportunities from the heightened volatility around news events and headlines.
  • High-frequency trading (HFT): these strategies use sophisticatedalgorithmsto exploit small or short-term market inefficiencies up to several thousand times in a single day.

Advantages and Disadvantages of Day Trading

No Overnight Moves

The most significant benefit of day trading is that positions are not affected by the possibility of negative overnight news that has the potential to impact the price of securities materially. Such news includes vital economic and earnings reports, as well as broker upgrades and downgrades that occur either before the market opens or after the market closes.

Higher Margins and Easier Exits

Another advantage is the ability to use tight stop-loss orders—the act of raising a stop price to minimize losses from a long position. Another includes the increased access to margin—and hence, greater leverage. Day trading also provides traders with more learning opportunities.

Higher Costs

Intraday traders may have insufficient time for a position to see a profit. There are also increased commission costs due to trading more frequently, which eats away at the profit margins a trader can expect.

Higher Risks

Day traders that engage in short selling or use margin to leverage long positions can see losses amplify quickly, leading to margin calls.

Pros

  • Positions are usually closed at the end of each day, and are so unaffected by risk from overnight news or off-hours broker moves.

  • Tight stop-loss orders can protect positions from extreme movements.

  • Regular traders have access to increased leverage and lower commissions.

  • Numerous trades increase hands-on learning experience.

Cons

  • Frequent trades do mean multiple commission costs.

  • Some assets are off-limits, like mutual funds.

  • There may not be sufficient time for a position to realize a profit before it has to be closed out.

  • Losses can mount quickly, especially if margin is used to finance purchases. Margin calls are a real risk.

Example of Day Trading

Zack is a day trader who uses technical analysis to make trades with his brokerage account. By analyzing price trends over a single day, he is able to predict short-term movements to score a small profit several times per day.

During a typical trading day, Zack will watch metrics such as the Relative Strength Index and the Intraday Momentum Index to evaluate whether a particular stock is oversold or undersold. He may also use margin trading to increase his profits. He may also use stop-loss orders to exit positions quickly if the market turns against him.

If Zack is a successful day trader, then he expects to have more profitable trades than losing ones over the course of the day. However, one bad trade could wipe out his margin position. Due to this risk, day trading is sometimes compared to "picking up pennies in front of a steamroller."

Day Trading vs. Other Types of Trading

Day trading is one of several strategies for professional stock traders. Unlike other traders, they look for predictable price patterns and small corrections over the course of a single trading day. Although the profits are relatively small, they can accumulate over a long-enough time frame. Day traders typically close out their positions at the end of the trading day, reducing their exposure to swings in the overseas markets.

In contrast, swing traders try to anticipate the peaks and troughs of a stock's price movements over a longer time frame, often weeks or months. With the right strategy, swing traders can earn higher profits than intraday traders, but they have to spend more time looking for suitable stocks.

Similar to swing traders, trend traders examine a stock's momentum and moving averages to determine whether a stock is likely to move higher or lower. They then buy stocks with a strong upside, or short those likely to trend lower. Trend traders are likely to look for chart patterns or technical indicators in their forecasts.

How to Become a Day Trader

Becoming a successful day trader requires a great deal of personal discipline. Novice day traders should expect to lose money as they learn the ins and outs of the market and be psychologically prepared for further losses over the course of their careers.

Day trading also involves a great deal of research, not only into the fees and commissions on their trades but also the relevant taxes and regulations. For example, day traders should be cognizant of the wash sale rule, which prohibits repeated transactions of the same security within a 30-day period. They should also fully understand the risks, especially of trading on margin.

Can You Get Rich Day Trading?

While some day traders can make money, studies suggest that the majority either lose money or underperform the market. Studies by professional economists suggest that most day trading strategies are no more effective than random chance.

What Are the Tax Implications of Day Trading?

Intraday trades are considered short-term capital gains, meaning that they are taxed at the same level as your income. You are required to pay taxes on each profitable trade, but you can use your losing trades to offset the taxes on your gains. You can also use up to $3,000 of losses to offset income tax on your salary, and carry over additional losses to the next tax year.

How Much Can I Make Day Trading?

While most day traders lose money, there are day traders who can make a profit. Zippia estimates that the average income of successful day traders is about $117,000 per year, or about $56 per hour. However, there are also risks—solo day traders must also trade with their own money, which comes with much greater risk than an ordinary salary.

The Bottom Line

Day traders look for extremely short-term price changes in the stock or forex market, allowing them to accumulate profits over the course of a trading day. Although it can be profitable, it also comes with a high degree of risk—especially for traders on margin positions. In addition to a thorough understanding of the stock market, day traders must also exercise self-control and avoid impulsive mistakes.

Day Trader: Definition, Techniques, Strategies, and Risks (2024)

FAQs

Day Trader: Definition, Techniques, Strategies, and Risks? ›

A day trader is a type of trader who executes a relatively large volume of short and long trades to capitalize on intraday market price action

price action
Price action is a method of analysis of the basic price movements to generate trade entry and exit signals that is considered reliable while not requiring the use of indicators. It is a form of technical analysis, as it ignores the fundamental factors of a security and looks primarily at the security's price history.
https://en.wikipedia.org › wiki › Price_action_trading
. The goal is to profit from very short-term price movements. Day traders can also use leverage to amplify returns, which can also amplify losses.

What are the strategies for day trading? ›

Common day trading strategies include Momentum, Breakout, Range, Reversal, Gap, Trend Following, Mean Reversion, Scalping, News, Pattern, Support and Resistance, Fibonacci, Volume Spread Analysis (VSA), Event-Driven, Arbitrage, and Statistical Arbitrage, each with its own set of rules and indicators for entering and ...

What is day trading and what are the risks? ›

Bottom Line Up Front. Day trading is buying and selling stock on the same day, hoping to make money in a short time by watching prices closely. Tax consequences and other risks can result from day trading – your profits are liable for a short-term capital gain tax at the income tax level you fall under.

What defines a day trader? ›

Day trading refers to a trading strategy where an individual buys and sells (or sells and buys) the same security in a margin account on the same day in an attempt to profit from small movements in the price of the security.

What are the 4 types of trading strategies? ›

What is a trading style?
Trading styleTimeframeCommon holding period
1. Position tradingLong termMonths to years
2. Swing tradingShort to medium termDays to weeks
3. Day tradingShort termIntraday only
4. Scalp tradingVery short termSeconds to minutes

How much money do day traders with $10000 accounts make per day on average? ›

With a $10,000 account, a good day might bring in a five percent gain, which is $500. However, day traders also need to consider fixed costs such as commissions charged by brokers. These commissions can eat into profits, and day traders need to earn enough to overcome these fees [2].

What should you not do in day trading? ›

What Should You Not Do in Day Trading?
  • Don't trade without a plan: It is critical to have a well-defined trading plan before entering any trade. ...
  • Don't overtrade: One of the most common mistakes made by day traders is placing too many trades in a short period of time, which is also known as overtrading.

What is the safest day trading strategy? ›

Place an actual stop-loss order at a price level that suits your risk tolerance. This level represents the most money that you can stand to lose. Set a mental stop-loss order at the point where your entry criteria would be violated. If the trade takes an unexpected turn, you'll immediately exit your position.

Why is day trading illegal? ›

Day trading is not illegal when it is done within normal trade hours and properly recorded. However, a similar practice known as late day trading is illegal and can be prosecuted under commodities fraud law.

What is the 3 5 7 rule in trading? ›

What is the 3 5 7 rule in trading? A risk management principle known as the “3-5-7” rule in trading advises diversifying one's financial holdings to reduce risk. The 3% rule states that you should never risk more than 3% of your whole trading capital on a single deal.

Do day traders need a license? ›

There are no explicit requirements for becoming a day trader, but a technical and expansive knowledge of how financial markets work, as well as a comfort with electronic trading platforms, and the rules and regulations of trading is essential.

Do day traders actually make money? ›

Day trading is a strategy in which investors buy and sell stocks the same day. It is rarely successful, with an estimated 95% loss percentage. Even if you do see a gain, it must be enough to offset fees and taxes, as well.

Is it legal to be a day trader? ›

Day traders usually buy on borrowed money, hoping that they will reap higher profits through leverage, but running the risk of higher losses too. While day trading is neither illegal nor is it unethical, it can be highly risky.

What is the easiest trading strategy? ›

Moving averages are the perfect beginner trading strategy in my opinion. They clearly visualize the trend and provide straightforward trade signals. I would recommend starting with the 20 and 50-day SMAs and then optimize from there once you gain more experience. Always use stops to manage risk.

What is the golden rules of trading? ›

Let profits run and cut losses short Stop losses should never be moved away from the market. Be disciplined with yourself, when your stop loss level is touched, get out. If a trade is proving profitable, don't be afraid to track the market.

What is the most profitable way to day trade? ›

Leverage. Day traders often use leverage for their investments. This means trading with borrowed money, using margin. Margin trading has the chance for much higher gains if your trades go well, but you can lose money much more quickly too.

What is the most successful day trading pattern? ›

The best chart patterns for day trading include the triangle, flag, pennant, wedge, and bullish hammer chart patterns.

Can you day trade with 1000 dollars? ›

You need to know how much money you're able to risk on each trade. The recommendation is that you risk a maximum of two percent of your account per trade. When trading with just $1,000 and starting out as a trader, avoid trading on margin. Get comfortable with general day trading first.

What type of day trading is best for beginners? ›

Overview: Swing trading is an excellent starting point for beginners. It strikes a balance between the fast-paced day trading and long-term investing.

References

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