Day trading is the buying and selling of financial assets with the goal of earning a profit on the same day.
Here we'll cover the basics of day trading, the various types, and whether day trading is the right investment strategy for you.
Definition and Example of Day Trading
Day trading was first available only to professional financial institutions, since they were the only actors who had access to the exchanges and market data for futures, options, currencies, and stocks. However, advances in technology and the internet have opened these markets up to everyone.
Day Trading Defined
Day trading involves buying and selling stocks, securities, currencies, or commodities with the goal of entering and exiting the position for a profit within the same day. Some day traders use economic events and corporate earnings reports to trade the swings in prices if the reported figures outperform or underperform expectations.
Day traders often monitor the markets, looking for short-term patterns or signals that might indicate the price action's direction in the future. Day trading typically involves executing trades very quickly. Unlike long-term investors, day traders rarely (if ever) hold assets overnight or when the market being traded is closed.
Example of Day Trading
Suppose that a day trader was watching the Federal Reserve central bank meeting since the Fed was expected to provide its economic outlook for the U.S. economy and its decision on whether to hike interest rates. As a result, the trader is looking to buy or sell the euro versus the U.S. dollar exchange rate, which before the Fed's decision traded at $1.10 for one euro, meaning it costs just over one dollar to buy one euro.
The Fed's decision is released, and the central bank has hiked interest rates, citing a robust U.S. economy and higher wages for workers. As a result, the dollar strengthens against the euro, sending the EUR/USD exchange rate downward.
The day trader executes a trade to sell euros against the dollar at $1.10, hoping to benefit from the expected depreciation. The EUR/USD drops from $1.10 to 1.09 within the next hour, and the trader exits the position for a profit of 0.0100 or approximately 1%. If the day trader had used leverage, borrowing $100,000 from a broker, the trade would have earned $1,000 minus any fees and margin borrowing costs.
How Day Trading Works
There are many types of day trading, each with features suited to different trader styles. They range from short-term trading, such as scalping where assets are only held for a few seconds or minutes, to longer-term swing and position trading where an asset may be held throughout the trading day.
Even though it may seem like they buy and sell on the fly, swing traders often look for patterns that can occur over many days or weeks.
Most day trading systems are flexible, allowing for positions to remain open for anywhere from a few minutes to a few hours. How long the trade remains open can depend on how the trade is performing or whether there are upcoming events that have yet to hit the market.
The main types of day trading markets are futures, options, currencies, and stocks. Within these types, there are groups of markets based on stock indexes (such as the Dow Jones and the DAX), currency exchange rates (such as the Euro to U.S. Dollar exchange rate), and commodities (such as gold and oil).
Day traders can access all of the exchanges and their markets via direct access brokers, because they offer direct access to the exchanges. Going through a broker is the fastest way to engage in trading at the lowest cost.
Day Trading vs. Swing Trading
|Day Trading||Swing Trading|
|Trades are made in the same day.||Trades are made over days or weeks.|
|Assets need constant watch.||Trader can watch assets less often.|
|Relies mostly on how aware a trader is of the market.||Relies mostly on technical analysis.|
|Can be large trades.||Mostly done with smaller trades.|
Types of Day Trading
Most day traders will choose a single type of trade, but some traders will take different types and choose which one to trade based on the current state of the market. The types include:
- Trend trades: Trades in the trending direction of the current price movement (i.e., buying if the price is moving up)
- Counter-trend trades: Trades against the direction of the current price movement (i.e., selling if the price is moving up)
- Range trades: Trades when the market is moving sideways, meaning the price is fluctuating between two price levels marking the high and low for that period
Is Day Trading for Everyone?
In addition to the style and type of day trading, there are other variances among day traders. Some day traders like to place trades throughout the trading day, while others prefer to wait for the best conditions, perhaps making only one trade per day. Regardless of how many trades are made, the trading process and the goal of earning a profit are the same.
Risks to Novice Investors
If you are a novice investor with limited experience and knowledge of the markets, day trading can be very risky and might not be a good option. Most day traders have had significant training or practice before deciding to go this route. One of the reasons to be cautious is that large amounts of money can be lost in a moment with just one bad trade. Traders without proper training can get caught up in the rush of one or two big wins.
Risk of Leverage
Day trading can be particularly risky if a novice trader borrows money to take advantage of a trading opportunity, and the market moves against the position. It's important to remember that borrowing money from a broker can increase the position size and magnify trading profits. However, leverage can also exacerbate trading losses when the trade goes badly. Unlike the brokers who are trading other people's money, individual day traders are putting their own assets at risk.
- Day trading is the buying and selling of financial assets designed to make a profit in the same day.
- Day traders buy and sell various investments, including stocks, commodities, and currencies.
- Most day traders keep a close watch on their positions at all times, but trades can be entered and exited within hours or minutes.
- Traders can gain great rewards, but are also at risk of losses, since the market can move against them quickly.
- Using leverage can help day traders increase their position size and magnify profits, but leverage can also magnify trading losses.