There are many approaches to taking on the stock markets with some strategies requiring more patience than others. This is not the case with day traders, as they seek to make small gains on short term positions.
The basic premise of day trading
In short, a day trader is someone who opens and then closes a position within the same day. The trader can open and close multiple trades, provided they have closed their positions come the end of the day. The trader will make use of long and short trades, as they aim to take advantage of temporary supply and demand issues within market pricing.
Typically speaking, you are only classified as a day trader by FINRA (Financial Industry Regulatory Authority) if you open and close at least 4 trades within a 5-day period. The number of trades will also need to make up at least 6% of the trader’s total trades. If you tick these boxes, you are then known as a pattern day trader. (1)U.S. Securities and Exchange Commission."Margin Rules for Day Trading." (2)Financial Industry Regulatory Authority."Am I a Pattern Day Trader? Know the Day-Trading Margin Requirements."
A day trader is looking to make the most of smaller price movements within the same day. Unlike your average investor who looks to the future growth of a security, a day trader is looking at the immediate term. Volatility in price movements is the day trader’s biggest ally. Whether they invest in or short a stock, its volatility of the price movements (value) of these securities where day traders find their profits.
There are a number of factors that can impact the price movements of securities. Let’s take a look at what your average day trader needs to take into account before they open their daily positions.
What can affect day trading?
Day trading requires attention to detail and continued observation throughout the day to make sure that the trader is capitalizing on any external factors that might influence the price movements of stocks.
What external factors could a day trader use to their advantage? The most obvious would be a combination of news, blogs and industry performance. A day trader needs to keep their finger on the pulse which includes constantly checking on the minor changes of corporations. This could mean anything from a company policy change or the launch of a new product to company mergers and changes in key staff members.
Another external factor that can impact day traders is governmental policy changes. If you are trading across markets, then these changes can be especially important. Staying up to date with economic policies is vital to the success of day traders. Governments and financial institutions regulate stock markets, their policies and interest rates. The slightest changes in these policies and rates could make for a significant opportunity for day traders.
News and blogs can sway the minds of the public but the opinion of industry analysts can greatly impact stock price movements. Analysts will take a magnifying glass to market trends and give the public their opinion. This can greatly impact intraday price movements. If analysts are touting the growth of a certain market, this can lead to increased stock purchases within that industry. This information all serves the day trader when used effectively.
The benefits of being a day trader
There are a number of advantages to day trading but the primary benefit is that your positions are not subject to the whims of negative overnight news. Your position won’t be impacted by overnight price movements, as you will almost always close your position before the close of day.
Another key benefit to day trading is the fact that your investments compound more swiftly, assuming you have made a profit on your trades. Most day traders are able to take the previous day’s profits and use them to reinvest in the following day’s trades.
Day traders also have greater access to margin trading which means they have more access to trading with leverage. Leverage can turn meager profits into larger ones. It also allows traders to trade with greater capital.
The risks of being a day trader
Just as there are benefits to day trading, there are also a few risks involved with this kind of trading. For one, trading with too much leverage can result in financial losses. You may have the chance to increase your profits but when you buy stocks on margin, you also expose yourself to the risk of losing more money than you initially invested in the stock.
Financial loss is essentially your greatest threat with day trading. Even if you avoid the use of leverage on your trades, you can still suffer financial losses as you are tied to the whims of ever shifting markets. That is why day trading requires such focus and dedication.
Another negative of day trading to consider are the taxes. Long term gains from a security that you have held for more than a year will be taxed at a lower rate. Day trading on the other hand sees traders taxed at a normal rate for gains that they have held for less than a year. The tax implications for day traders are typically much more strenuous.
Day trader strategies
There are a number of established day trading strategies that have been developed. Here are the most well-thought strategies that are used everyday:
High-frequency trading (HFT)
This type of day trading strategy will often need the assistance of computer software, as the trader will try to establish detailed algorithms to exploit short-term market inefficiencies, sometimes several thousand times in one day. The key here is to use a top-quality platform that uses effective algorithms to do the work for you.
This is all about allowing support and resistance levels to determine when to buy and sell. This type of trading strategy is also known as swing trading but only when positions are held open for weeks as opposed to hours like in day trading.
Scalping is high volume day trading that aims to make small profits on smaller price movements in the market with specific focus on arbitrage opportunities.
As we mentioned earlier, day traders will often make use of scheduled news announcements. This allows them to seize on immediate trading opportunities that they believe will heighten market volatility. The type of news day traders look out for can be anything from acquisitions and mergers to yearly earnings announcements and changes in Officer roles in a company.
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