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What is Day Trading?
The financial market is made up of several different types of market participants. These include both investors and traders. Investors generally invest in assets like stocks and bonds and wait for the asset’s value to increase to generate a profit. They usually have a long-term investment horizon and invest with the intention of holding onto their investments for more than a year. However, on the other hand, traders are people who usually enter and exit trades within a very short duration that can last from a few minutes, hours to a few days.
Both these market participants have the common goal of generating money from the market, however, both utilize completely different techniques. While investors invest in growth stocks that have the ability to multiply their investment by several times, traders capitalize on short-term trends that can generate smaller profits in a short duration of time. You may have heard about day trading. We at financial education believe that one should be aware and have knowledge of what day trading is this is a very lucrative career one can choose to follow. Day trading or intra-day trading is a form of speculation of assets like stocks where a trader buys and sells a financial instrument within the same trading day and closes his positions before the market closes.
This allows traders to utilize the benefit of leverage and also avoid taking risk of holding overnight positions. While day trading might seem like an attractive method of generating quick money, in reality, day trading is highly challenging and requires discipline and extensive knowledge of how the market functions. In this article, we shall go over what day trading is, how professional traders trade the markets, and much more. So, let’s get started!
What is Day Trading
Day trading is a form of speculation in securities where a trader buys and sells stocks within the same trading day and closes all his positions before the market closes. This gives the trader the benefit of leverage as he can take on large position sizes which wouldn’t have been possible if he was to hold the positions overnight. However, founder of Financial Education, Jeremy Lefebvre, believes that leverage is a double-edged sword, which if used properly can generate huge wealth, but if mismanaged; it can cause wealth destruction. Day trading also reduces the risk of price gaps and the risk of holding positions overnight. Utilizing margin benefit or leverage, traders can take up positions much larger than their actual capital allows, thus the profits are magnified, but so are the losses. Basically, day traders are people who actively trade the markets and close all their positions within a single trading day while executing intraday strategies in order to profit from price changes in any given asset.
Day trading or intra-day trading was once something that was only accessible to people who were working for brokerages, large financial institutions, and trading houses. However, with the introduction of online brokerages and trading houses, trading actively in the stock market has become accessible to all. While day trading can be a very lucrative career, as it offers the potential of generating huge returns within a short duration of time, we at Financial Education believe that it can be equally risky and can cause huge losses if done without proper knowledge and experience. Day trading utilizes a wide variety of strategies and techniques to capitalize on high probability movements in the stock market.
Generally, day traders are highly skilled and educated individuals who can manage their emotions, risk and be disciplined while trading the market. Day traders have to be well funded in order to meet the margin requirements set by exchanges and the SEC, as using leverage allows traders to generate huge returns if their analysis and judgment of market movements are proved correct. Using short-term trading strategies, day traders are able to capitalize on short-term market trends. Volatility and sudden market movements can benefit a trader if they have the right analysis and judgment of the movement.
Characteristics of a Professional Intraday Trader
Now that you have an idea of what day trading is, it is crucial to understand who day traders are and what characteristics make a person a successful intraday trader. Professional day traders are people who trade for a living and treat reading as a business, rather than a hobby or part-time gig. Day traders usually have extensive knowledge of the financial markets and are skilled professionals who use technical analysis and several trading strategies in order to generate profits from the market. There are several different types of trading styles like swing trading, day trading, scalping, algorithmic trading, and more. Founder of Financial Education, Jeremy Lefebvre, believes that actively trading the markets requires one to be extremely skilled with their entries and exits and maintain discipline to minimize the effect of emotions on their trading performance. Here are some of the characteristics of a professional intraday trader that make them successful –
Knowledge and Experience
Actively trading the financial markets without knowledge or experience can be extremely dangerous for a beginner as leverage can cause huge losses if not used properly. Professional day traders who trade for a living are extremely knowledgeable about the stock market, finance, and economic factors that can affect the market and stock prices.
Another aspect that traders have to master in order to become a profitable intraday trader is technical analysis and understanding of how the market functions and reacts to certain events. Chart reading is another crucial skill that professional traders need to have as analyzing the price movement of a stock can only be done if one can understand the various chart patterns and then create strategies that will work best with them.
Proper Account Size & Capital
In order to actively trade the markets and utilize the benefit of leverage, traders need to have a margin account. In order to have a margin account, traders need to have sufficient capital in their account as entering intraday positions in the market requires a lot of margin and additional capital in order to meet margin shortfalls and position adjustments.
Professional traders are usually well funded and know how to manage their risk per trade. They never risk more than 2% of their overall capital on a single trade. Volatility and sudden swings in the market can cause the margin requirements to go up suddenly, therefore margin shortfalls can occur. This is why having a proper account size with sufficient capital is essential to succeed as a professional day trader.
Psychology and Discipline
Professional traders who trade the markets for a living are extremely disciplined when it comes to following their rules and trading system. Having a proper mindset and psychology when trading is essential in order to remain profitable over the long run and generate huge returns as a day trader. Without discipline and proper psychology, traders often end up losing their capital within a matter of days.
This is because emotions like greed, fear, and indecision take control of the mind of a trader. According to data, 90% of day traders end up losing 90% of their capital in 90 days. This is because they do not follow their rules and strategy and often end up holding on to their losses due to improper risk management and lack of discipline while trading. So, proper psychology and discipline are essential to succeed as an intraday trader.
Strategy and Trading Plan
In order to remain consistently profitable while actively trading the market, day traders need to follow their trading plan and have proper strategies in place. Having a well-designed strategy that has been backtested allows traders to benefit from market swings and capitalize on short-term moves. Backtesting and trading strategies need to be constantly monitored and adjusted according to the market sentiment. Without proper trading strategies in place, a trader will end up losing all their capital in just a matter of days.
Additionally, having a trading plan which specifies the exact entry and exit points, along with the stop loss is crucial to success as a day trader. Having a trading plan reduces the involvement of emotions in trading and allows traders to follow a rules-based system that provides everything from entries, exits, and stop losses in order to maintain discipline and ensure risk management is followed. Therefore, proper trading strategies and a trading plan are essential to succeed as a professional day trader.
Techniques and Methods Used in Day Trading
Traders who trade the markets actively utilize several trading techniques, styles, and methods in order to generate profits from short-term trends. We at Financial Education believe that day trading requires traders to have a reliable trading strategy that has been backtested and provides a statistical edge in order to remain profitable in any market condition. Traders can utilize several trading methods, styles, and strategies while trading the market, some of them are –
1. Trend Trading
Trend trading or also known as momentum trading is a strategy that is used in all trading time-frames. This strategy assumes that the financial assets which have been rising steadily will continue to rise, and vice versa with falling. Traders can profit by buying an instrument that has been rising, or short selling a falling one, in the expectation that the trend will continue. Trend traders also use technical analysis to identify the exact entry and exit points.
2. Range Trading
Range trading, or range-bound trading, is a trading style in which stocks are watched that have either been rising off a support price or falling off a resistance price. That is, every time the stock hits a high, it falls back to the low, and vice versa. Such a stock is said to be “trading in a range”, which is the opposite of trending. The range trader, therefore, buys the stock at or near the low price and sells (and possibly short sells) at the high. A related approach to range trading is looking for moves outside of an established range, called a breakout (price moves up) or a breakdown (price moves down), and assume that once the range has been broken prices will continue in that direction for some time.
Scalping was originally referred to as spread trading. Scalping is a trading style where small price gaps created by the bid-ask spread are exploited by the speculator. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds. Scalping highly liquid instruments for off-the-floor day traders involves taking quick profits while minimizing risk (loss exposure). It applies technical analysis concepts such as over/under-bought, support and resistance zones as well as trendline, trading channel to enter the market at key points and take quick profits from small moves. The basic idea of scalping is to exploit the inefficiency of the market when volatility increases and the trading range expands. Scalpers also use the “fade” technique. When stock values suddenly rise, they short sell securities that seem overvalued.
4. Price action trading
Price action trading relies on technical analysis but does not rely on conventional indicators. These traders rely on a combination of price movement, chart patterns, volume, and other raw market data to gauge whether or not they should take a trade. This is seen as a “minimalist” approach to trading but is not by any means easier than any other trading methodology. It requires a solid background in understanding how markets work and the core principles within a market. However, the benefit of this methodology is that it is effective in virtually any market (stocks, foreign exchange, futures, gold, oil, etc.)
5. Algorithmic trading
It is estimated that more than 75% of stock trades in the United States are generated by algorithmic trading or high-frequency trading. The increased use of algorithms and quantitative techniques has led to more competition and smaller profits. Algorithmic trading is used by banks and hedge funds as well as retail traders. Retail traders can buy commercially available automated trading systems or develop their own automatic trading software.
Difference Between Trading and Investing
Trading and investing are two completely different ways of making money in the financial market. Investing is the art of creating wealth by holding on to investments for a long period of time whereas trading is something that is short-term and focuses on capitalizing short-term trends in the market. Investing and trading are two very different methods of attempting to profit in the financial market. Both investors and traders seek profits through market participation. In general, investors seek larger returns over an extended period through buying and holding. Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a shorter timeframe, taking smaller, more frequent profits.
Some of the key differences between trading and investing are –
- Time Horizon: Trading and investing are two completely different ways of making money from the financial market. A trader holds stocks to capitalize on short-term market swings, whereas, investing is an approach that works on buy-and-hold principles. Investors generally hold on to their investments for long periods and tend to prefer growth stocks so they can compound wealth. On the other hand, traders do not hold their positions for a long time and usually trade and capitalize on short-term trends where they mostly hold their trades from a few hours to a few days.
- Risk and Reward: Undoubtedly, both trading and investing imply risk on your capital. However, trading comparatively involves higher risk and higher potential returns as the price might go high or low in a short while. Since investing is an art, it takes a while to develop. It involves comparatively lower risk and lower returns in the short run but might deliver higher returns by compounding interests and dividends if held for a longer period of time.
Trading and investing are two different ways of approaching the financial market. With trading, one hopes to earn quick returns based on short-term fluctuations and swings in the market. Long-term investors on the other hand tend to build diversified portfolios of assets and stay in them through the ups and downs of the market in order to generate wealth using compounding and dividends by investing in quality growth stocks. However, before making any investment decision, always check the current market conditions and other factors that might affect the value of an asset class, as investments in the financial market are subject to market risk. If you liked this article, make sure to visit Jeremy Lefebvre’s YouTube channel “Financial Education” for more such informative content! Happy investing!