Day Trading: An Introduction

By Justin Kuepper | Updated August 6, 2018 — 9:06 PM EDT

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What exactly is day trading? Who participates in the process? Can and should
you get involved?

Day trading is defined as the buying and selling of a security within a single
trading day. This can occur in any marketplace, but is most common in the
foreign-exchange (forex) market and stock market. Typically, day traders are
well-educated and well-funded. They utilize high amounts of leverage and
short-term trading strategies to capitalize on small price movements in highly
liquid stocks or currencies.

Day traders serve two critical functions in the marketplace: They keep the
markets running efficiently via arbitrage, and they provide much of the
markets' liquidity (especially in the stock market). This article will take an
objective look at day trading, who does it and how it is done.

The Controversy
The profit potential of day trading is perhaps one of the most debated (and
misunderstood) topics on Wall Street. Countless internet scams have
capitalized on this confusion by promising enormous returns in a short period
of time. Meanwhile, the media continues to promote this type of trading as a
get-rich-quick scheme.

There are those who engage in this type of trading without sufficient
knowledge; however, there are day traders who make a successful living
despite, or perhaps because of, the risks.

Many professional money managers and financial advisors shy away from day
trading, arguing that, in most cases, the reward does not justify the risk.
Conversely, those who do day trade insist that there is profit to be made. Still,
they admit that the success rate is inherently lower as a result of the higher
complexity and necessary risk of day trading, combined with all the related
scams.

Day trading is not for everyone and involves significant risks. Moreover, it
demands an in-depth understanding of how the markets work and various
strategies for profiting in the short term.

Characteristics of a Day Trader

This article focuses on professional day traders – those who trade for a living,
not simply as a hobby or for a "gambling high." These traders are typically
well-established in the field and have in-depth knowledge of the marketplace.
Here are some of the prerequisites to day trading:

Knowledge and Experience in the Marketplace: Individuals who attempt to

day trade without an understanding of market fundamentals often end up
losing money.

Sufficient Capital: One cannot expect to make money day trading. Day
traders use only risk capital, which they can afford to lose. Not only does this
protect them from financial ruin, but it also helps eliminate emotion from their
trading. A large amount of capital is often necessary to capitalize effectively on
intraday price movements.

A Strategy: A trader needs an edge over the rest of the market. There are
several different strategies that day traders utilize, including swing trading,
arbitrage and trading news. These strategies are refined until they produce
consistent profits and effectively limit losses.

Discipline: A profitable strategy is useless without discipline. Many day

traders end up losing a lot of money because they fail to make trades that
meet their own criteria. As they say, "Plan the trade and trade the plan."
Success is impossible without discipline.

Day Trading for a Living

There are two primary divisions of professional day traders: those who work
alone and/or those who work for a larger institution. Most day traders who
trade for a living work for a large institution. The fact is, these people have
access to things individual traders could only dream of, such as a direct line to
a trading desk, large amounts of capital and leverage, expensive analytical
software, and much more. These traders are typically the ones looking for
easy profits that can be made from arbitrage opportunities and news events,
and these resources allow them to capitalize on these less risky day trades
before individual traders can react.

Individual traders often manage other people's money or simply trade with
their own. Few of them have access to a trading desk, but they often have
strong ties to a brokerage (due to the large amounts they spend on
commissions) and access to other resources. However, the limited scope of
these resources prevents them from competing directly with institutional day
traders. Instead, they are forced to take more risks. Individual traders typically
day trade using technical analysis and swing trades – combined with some
leverage – to generate adequate profits on such small price movements in
highly liquid stocks.

Day trading demands access to some of the most complex financial services
and instruments in the marketplace. Day traders require:

Access to the Trading Desk: This is usually reserved for traders working for
larger institutions or those who manage large amounts of money. The dealing
desk provides these traders with instantaneous order executions, which can
become important, especially when sharp price movements occur. For
example, when an acquisition is announced, day traders looking at merger
arbitrage can get their orders in before the rest of the market, taking
advantage of the price differential.

Multiple News Sources: In the movie "Wall Street," Gordon Gekko says that
"information is the most important commodity when trading." News provides
the majority of opportunities day traders capitalize on, so it is imperative to be
the first to know when something big happens. The typical trading room
contains access to the Dow Jones Newswire, televisions showing CNBC and
other news organizations, as well as software that constantly analyzes various
other news sources for important stories.

Analytical Software: Trading software is an expensive necessity for most day

traders. Those who rely on technical indicators or swing trades rely more on
software than news. This software typically contains many features, including:

 Automatic pattern recognition: This means that the trading program

identifies technical indicators like flags and channels, or more complex
indicators like Elliott Wave patterns.
 Genetic and neural applications: These are programs that utilize neural
networks and genetic algorithms to perfect trading systems to make
more accurate predictions of future price movements.
 Broker integration: Some of these applications even interface directly
with the brokerage, which allows for an instantaneous and even
automatic execution of trades. This is helpful for eliminating emotion
from trading and improving execution times.
 Back testing: This allows traders to look at how a certain strategy would
have performed in the past in order to predict more accurately how it will
perform in the future (although past performance is not always
indicative of future results).

Combined, these tools provide traders with an edge over the rest of the
marketplace. It is easy to see why, without them, so many inexperienced
traders lose money.

The Bottom Line

Although day trading has become somewhat of a controversial phenomenon,
its prevalence is undeniable. Day traders, both institutional and individual, play
an important role in the marketplace by keeping the markets efficient and
liquid. While popular among inexperienced traders, it should be left primarily to
those with the skills and resources needed to succeed. If you find day trading
interesting and would like to take a further step into researching the different
brokers available, Investopedia has curated a list of the best stock brokers for
day trading.

Read more: An Introduction To Day

Trading https://www.investopedia.com/articles/trading/05/011705.asp#ixzz5Wk7NLw
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