A Beginner’s Guide to Day Trading

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Day trading has recently seen emerging interest since the COVID-19 lockdowns due to its reputation for speedier returns. That said, its nuances and characteristics are still unknown to many. 

What is Day Trading?

Also called intraday trading, day trading is the activity of purchasing and selling financial instruments, such as stocks or currencies, within the same day. 

Day traders work on the assumption that prices will rise and fall in value during the day, thus generating opportunities for profit, but also possibilities of loss.

Day trading is a short term strategy and doesn’t depend on future stock or currency movement. Furthermore, in day trading, all positions are squared-off before the market closes, and there aren’t any changes in ownership of shares as a result of the trades.

Also read our article on “Day trading vs Swing trading

Advantages of Day Trading

Day trading occurs within a relatively short time frame, typically the same day. As such, positions typically represent a small percentage of a retail trader’s portfolio. It is possible for retail traders to execute large volumes of trades daily or weekly to make a quick profit on small fluctuations on specific trading patterns repeatedly within the day.

Other advantages of day trading are:

  • No overnight risk as positions are unaffected by risk from overnight news or off-hours broker moves.
  • Tight stop-loss orders can protect positions.
  • Numerous trades increase hands-on learning experience.
  • Earnings compound faster
  • Interest can be made on one’s cash position
Day Trading
Photo by Austin Distel on Unsplash

Challenges with Day Trading

  • Intermittent losses: Day trading can be highly lucrative if executed smartly. It can also, unfortunately, result in substantial losses from bad trades. Intraday trading is typically touted as a “get rich approach” to the stock market, which is a poor and uninformed mentality to take.
  • Necessitates discipline and frequent monitoring: Intraday trading requires discipline and focus since day traders execute more trades on a volume basis than average investors. As such, day traders have to frequently monitor their trading plans to ensure that their trades directly align with their trading rules.
  • Frequent trades mean multiple commissions and high trading costs.
  • Losses can quickly accumulate, especially if the margin is used to finance purchases.
  • Some assets are off-limits to day traders, like mutual funds.
  • Sometimes there isn’t enough time for a position to realise a profit before it has to be closed out.

How does day trading work?

As we have established, day trading strictly revolves around buying and selling financial instruments only within a day. 

This means that all positions are typically closed before the market closes for the trading day. Some traders may incorporate day trading as a component of their overall strategy, with only a small proportion of positions being closed out intraday.

Generally, the most common day-traded financial instruments are stocks, options, currencies, and futures contracts like equity index futures, interest rate futures, currency futures and commodity futures.

Day traders are typically referred to as speculators since this approach of quick trading involves short term price movements and patterns, and contrasts with long-term trades and value investing strategies. 

Once exclusive to financial firms and professional speculators like banks or investment firms with the technology and resources, day trading has now become accessible to private individuals with the arrival of electronic trading systems and margin trading.

Day traders also look out for events that cause short-term market moves, scheduled announcements like economic statistics, corporate earnings, or interest rates which can affect market expectations and market psychology. 

Examples of Day Trading strategies

Scalping

Also called spread-trading, scalping is based on real-time technical analysis and involves holding a specific position for a very short duration of time for small profits. 

To make scalping an efficient strategy, small profits are accumulated throughout the day based on small price changes that happen within that given day. As trades are typically exited quickly after they become profitable, taking more trades allows for greater profit. 

Range trading

Range trading, also called channel trading, utilises support and resistance levels to determine purchase and sell decisions. When ‘trading in a range’, prices typically stay within the support and resistance levels, and extensively analysed to identify opportunities for buying at the low end of the range and selling at the high end of the range during the day.

range trading
Image by Sergei Tokmakov Terms.Law from Pixabay

News-based trading

This day trading strategy usually takes advantage of trading opportunities derived from the heightened volatility around current events and news. 

By focusing on key events and news releases that affect market prices and investor sentiment, day traders attempt to make profit off the quick changes in price as the market reacts to the news.

High-frequency trading (HFT)

This strategy leverages on complex algorithms to exploit small and short-term market inefficiencies on a large scale. It involves automated trading platforms and powerful computers and is as such mainly employed by investment banks, hedge funds, and institutional investors to run and execute large transactions at high speed. 

Such technologies enable traders to execute millions of orders concurrently, scan multiple markets and exchanges in seconds, and identify competitive edges and emerging trends in seconds. 

Breakout trading 

This approach entails trading in a range between support and resistance lines that have been holding strong consistently. Looking for signals, traders may take positions on either side of the range, in the hope that prices will ‘breakout’ from their existing range and form a new trend. 

Is it feasible to make a living as a Day Trader?

Day trading involves short and quick price movements within the day and requires traders to be able to react quickly to changes. As such, it is best suited for experienced investors who have deep knowledge of the instruments and markets they have chosen to trade-in. 

Technical analysis is also critical to a successful day trading strategy and allows traders to make use of different indicators to analyse the markets and develop an understanding of how a given asset may move, how strong the movement may be, and how long it could last. 

Still, in most cases, combining technical and fundamental analysis gives experienced investors an edge over others.

In order to be a successful day trader, it is also important to develop a clear day trading strategy with disciplined risk management limits. 

Day trading involves using high levels of leverage to control larger positions on the market with a smaller initial investment. This means that the price movements are often small, but leverage enables investors to maximise their profit in a single day. 

The inverse is also true –  financial leverage can be risky and requires a thorough understanding of the markets as loss can also be magnified. This is another reason why day trading is recommended only for experienced investors.

Overall, to possibly make a decent living off day trading, it is imperative to have a solid trading strategy that integrates technical analysis, discipline, appropriate tooling, and a keen understanding of trading psychology.

Conclusion

Day trading isn’t a get rich quick scheme, and one can lose all their money without the proper background and knowledge. 

Despite the existence of many successful day traders, having a solid execution, and an exit strategy, is a necessity. Overall, the risks involved in day trading can be justified with intelligent execution and discipline. 

For more information, reach us at Ortega Capital.

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