Day trading is a short-term time horizon strategy with the goal of attempting to make money quickly. While this approach could potentially lead to fast, short-term returns, the risks are also extremely high. If you’re considering day trading, here’s what you need to know.
What is day trading?
Day trading is an investment strategy where you buy and sell investments (e.g., stocks) usually within the same day in a relatively short period of time—such as within minutes or hours. A day trader could have multiple short-term positions open at the same time. Day traders can trade many possible investments, including stocks, ETFs, bonds, currencies, commodities, and crypto, and they aim to predict how prices for these investments change over short periods to potentially make money off these swings.
While day trading can be profitable, it is risky, time-consuming, and can be stressful. The majority of nonprofessional traders who attempt to day trade are not successful over the long term. Success can require dedication, discipline, and strict money management controls.
How do you day trade?
Day trading works by finding opportunities to profit from short-term asset price swings. For example, in the morning you might predict that a stock may increase in value by the afternoon, so you might buy early in the day and hope to sell in the afternoon at a higher price. Alternatively, if you think an asset’s price will fall in value, you could short sell early in the trading session before buying later at a lower price to close your position.
Since these price changes and potential profits can be fairly small, day traders may make many trades. A day trader might also use leverage, like borrowing money with margin loans to make larger investments than they could by using only the cash they have on hand. Leverage involves significant risk and can expose you to extreme losses.
Risks of day trading
High chance of losses. Day trading is a high-risk strategy. Whereas long-term investing has the benefit of time for an investment to pan out, day trading does not. If the market moves differently than you expected, you could lose substantial money—especially if leverage is employed. It’s critically important to understand the risks involved in day trading, manage all the risk that you are exposed to, and be prepared to accept losses.
Losses could force you to add more cash. Pattern day traders must maintain minimum equity of $25,000 in their margin account on any day that the customer day trades. This required minimum equity, which can be a combination of cash and eligible securities, must be in your account prior to engaging in any day trading activities. If the account falls below the $25,000 requirement, a pattern day trader won’t be permitted to day trade until the account is restored to the $25,000 minimum equity level.
If you borrowed funds via a margin loan to invest and the trade goes against you, your broker could also require you to add money quickly or else you’d be forced to sell other investments in your portfolio to cover the loss. A margin call is a demand from your brokerage firm to increase the amount of equity in your account. You can do this by depositing cash or marginable securities to your account or by liquidating existing positions to generate cash.
Higher tax rates and investment fees. Depending on the type of investment and where you trade, you may have to pay a trading commission. With day trading, you could have numerous transactions, potentially ramping up your trading expenses. In addition, when you sell an investment for a profit that you owned for less than a year, it may be subject to a higher short-term capital gain tax rate versus investments you held for over a year.
Day trading guide
Day trading is a big commitment. You must actively track your trades and should be able to react to breaking market news that could impact any of your positions. Most importantly, you must understand the heightened risks involved in day trading. If you understand these risks, here are some steps to help you get set up.
Step 1: Select the right broker
You need to pick an online brokerage platform that provides the features and tools best suited for your strategy. Each company has different trading tools, research, fee structures, and other characteristics.Step 2: Optimize your trading setup
Some people like to trade on the go, others might want a quiet, consistent location. What’s the best physical location and situation for your strategy? Will you trade on a computer or smartphone? Set yourself up for success by optimizing your setup.
Step 3: Find your trading strategy
Do you already have a trading strategy you find most appealing? If not, there are resources that can help you find one. Is there a specific industry or company you know well because of past work experience? You should have a plan for how to research strategies and trades. Most brokerage platforms provide research as well as access to market news. You could also join day trading communities or utilize webinars that provide trading education.
Step 4: Fund your account
You’ll need to deposit at least $25,000 to meet the account minimums for day trading. Note that you are likely to need more to give yourself a buffer against losses. From there, you can use your online brokerage platform to make the trades you want during the day.
Day trading strategies
Your trading strategy should fit your goals, risk tolerance, and liquidity needs. With that said, here are some of the most commonly used day trading strategies.
Range trading: An investment can oftentimes trade within an established price range throughout a particular day. If you can see a pattern, you might aim to buy when an investment is near the low point of its daily trading range and then sell once it returns to the high end. This might be accomplished by buying near a known level of support and exiting near a known level of resistance. This could be repeated often as the price cycles through the range.
Breakout trading: With breakout trading, you aim to find an investment with an established trading range where the price tends not to go above or below a certain point. A breakout occurs when the price finally exceeds the upper limit or falls below the lower limit. The idea is that, due to momentum, once it breaks out of the range the price could continue going in the same direction. A day trader might try to buy an investment beginning to break out and then sell at some future point when they believe the breakout to be over.
Pullback trading: Pullback trading is attempting to identify when a trend, such as a stock that has been rising in value over a period of time, may be coming to an end. A day trader might wait for the first sign that the trend is over (the pullback). Expecting the price to move in the opposite direction, you position yourself for the pullback.
News trading: With news trading, you anticipate how an investment might react to market-moving news. This could be in reaction to macroeconomic news, such as right after the Federal Reserve announces a change in interest rates, as well as more acutely with news that impacts an individual company or sector.
Is day trading right for you?
Day trading is tough. Studies have found that most day traders quit within a relatively short period of time, and that most individual day trades are unprofitable. If you really believe you have an edge against the typical professional investor and you have the time and money to spare, just know that you are going up against the odds. Given the extreme risks, you should carefully consider if it is right for you.
Besides day trading, there are other ways to potentially help make money investing. You could use more of a slightly longer-term, active trading style. Here, you still try to pick investments using short-term strategies that are more profitable than others, but you aren’t constantly trading during the day. You might take investment positions that last weeks or months versus those that only last a day.