A day trader is a trader who buys and sells a financial instrument or multiple financial instruments within the same day in large volumes. They typically execute multiple intraday orders and profit off small movements in prices.
In this in-depth guide you’ll learn:
- What is day trading?
- How does day trading work?
- What does a day trader do?
- Best trading strategies for day trading
- Financial instruments most suited to day trading
And lots more…
Let’s dive right in…
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👉 Intraday means “within the day”. This means a day trader trades financial instruments during regular business hours. Day traders close and settle all their positions at the end of the trading day when the market closes. They start with new positions when the market opens up the next morning.
👉 Day traders make their money from price action on securities that are affected by temporary supply and demand inefficiencies. Day trading can be lucrative but it’s associated with high risks and a high degree of uncertainty.
What does a day trader do?
👉 Day traders hold positions on a variety of underlying assets for short periods of time. Underlying assets include currency pairs, stocks, and shares, options, futures, and commodities. A day trader can hold a position for anything from a few minutes to a few hours before closing and settling a position.
👉 A day trader rarely holds a position overnight. The aim is to make money on short-term positions, capitalizing on small price fluctuations.
👉 The same risk management strategies apply to day trading. Traders set Stop-Loss Orders and Profit-Taking Orders on their positions to prevent losing more than they invest in a position.
👉 Day traders also trade on high amounts of leverage to magnify their exposure to a trade position. Leverage involves using borrowed money from the broker to open positions that are larger than they would open with their own capital. Leverage increases the potential profit on a position but it also magnifies the potential losses.
👉 Day traders use a variety of trading techniques and strategies to buy and sell securities. They rely heavily on technical analysis and the most successful are self-disciplined, objective and keenly tuned into the global financial markets and factors affecting price movements.
👉 Technical analysis is a valuable tool for day traders because it helps them spot trends. Technical analysis relies on the notion that underlying asset prices move up and down in trends and these trends tend to repeat themselves over time. Information on price trends and volume is plotted on charts which provide visual cues to buy and sell assets.
👉 Day traders have access to a range of financial instruments but it’s more common to find them operating in the forex market and stock market. These underlying assets are highly liquid which means they can easily be converted to cash.
👉 In the past, day traders were more often than not employed by large financial institutions or brokerage houses because these establishments are in a position to participate in high leverage trading positions. However, you’ll find that more and more private investors are venturing into intraday trading as online retail trading opens up to the broader market.
Most popular day trading strategies
👉 Day traders employ a range of intraday strategies to capitalize on price fluctuations on the underlying assets that they are trading. The most common are scalping, range trading, news-based trading, and high-frequency trading (HFT).
👉 Scalping is a strategy adopted by day traders to profit off small price changes throughout a single day. This is typically after a position is opened and becomes profitable.
👉 The scalping strategy relies on a day trader having a strict exit strategy. This allows a trader to make small gains on price movements before one large loss eliminates any profits.
👉 Scalping works based on small gains from multiple small trades, rather than a large gain from a large position that is left for a longer period of time to let the profit build up. The only way to make money with scalping is to have a much higher ratio of winning positions over losing positions.
👉 Pure scalpers make multiple trades in a day, sometimes in the hundreds. They use tick or one-minute charts with the smallest timeframe.
👉 Traders who trade in longer time frames often using scalping as a supplementary strategy, particularly when the market is what they call ‘choppy’. This is when prices swing up and down significantly in the short term or over an extended time period.
👉 The scalping strategy is useful where there are no trends in a longer time frame. Moving to a shorter time frame can reveal small price movements that can be exploited while waiting for bigger and more obvious price movements.
Range trading strategy
👉 The range trading strategy is where traders identify overbought and oversold assets. These are what are known as the support and resistance areas. Range trading aims to take advantage and profit on the tendency of prices to revert to the mean.
👉 Reverting to the mean is where a price either moves towards or away from its average price over time. Range traders create a moving average line by connecting each day’s moving average values. When prices move markedly above or below the moving average, they will eventually move in the direction of the average price.
👉 Range traders buy at the oversold area (support level) and sell at the overbought area (resistance level). This strategy is usually adopted in markets with prices that are rambling up and down with no obvious long-term trend.
👉 Range trading is not as effective in a trending market. It’s commonly used where a trader can interpret a bias in the market’s direction.
News-based trading strategy
👉 News trading is where traders go long (buy) or short (sell) on an underlying asset immediately after a major news event. News trading is one of the more popular trading strategies adopted by beginner day traders or small-time investors.
👉 Forex news trading is probably one of the most common forms of trading. Predicting price movements on currency pairs with the help of social media and active news feeds is exciting and can make instant profits for traders.
👉 What they call ‘trading on the news’ is capitalizing on forex and stock market fluctuations that occur when there is breaking news (natural disasters) or expected releases (financial reporting).
👉 Currency pairs and stock prices are intricately linked to supply and demand. If more people want to trade on a currency pair or buy stock, the market price will increase. If more people want to sell a stock, the price will fall.
👉 This is because the relationship between supply and demand is extremely sensitive to current affairs and political and socio-economic factors that influence market sentiment.
👉 A prime example of news affecting the supply and demand of currency and stocks is how the market reacted to the Covid-19 pandemic. The news of the outbreak had an unprecedented impact on the stock market with widespread panic selling.
👉 The trick with the news trading strategy is to anticipate events that will affect price movements, rather than react to them. Often it’s too late to respond to a reported event and you end up paying catch up on positions.
High-frequency trading (HFT) strategy
👉 High-frequency trading (HFT) uses sophisticated algorithms built into trading platforms such as MetaTrader 4 to pick up and exploit small or short-term market inefficiencies. An inefficient market is where asset prices do not accurately reflect their true value.
👉 Most markets experience some degree of inefficiency. In severe cases, an inefficient market results in deadweight losses and market failure.
👉 In inefficient markets, the currency and stock prices are so random, it’s almost impossible to find price patterns or date advantage of price movements. The fundamental and technical analysis becomes mute because the information is fairly useless. After all, an inefficient market does present a trend.
👉 Sophisticated algorithms automate the high-frequency trading system. This allows traders to buy and sell underlying assets at such extreme speeds that the transactions are measured in microseconds or even millionths of a second. An HFT trader buys and holds onto a position for a fraction of a second and then closes and settles it.
Financial instruments most suited to day trading
👉 Currencies and stocks most suited to day trading have generous liquidity, medium-to-high volatility, and group followers.
👉 Forex and stocks typically have high volume numbers. This means large quantities can be bought and sold without the price being significantly affected. This makes these assets highly liquid.
👉 Day trading is reliant on speed and the exact timing and large volumes make it easier for a day trader to get into and out of positions quickly and easily. Liquid markets are deeper and smoother, while an illiquid asset such as Bitcoin can put traders in positions that are difficult to exit.
👉 Day traders make money from small price fluctuations in a single day. This means they need to choose the stock that experiences relatively high volatility. They use tight timeframes and pick up minute price trends in short time periods.
👉 Volatility is a good thing for day traders because they can make money in choppy markets, making short-term profits from swing trading.
👉 Trend trading involves ‘following the group’. It’s a trading style that capitalizes on price movements by analyzing the momentum of an underlying asset in a particular direction. A trend is when a currency or stock price moves in one overall direction, either up or down.
👉 Trend traders will enter a long position (buy) when an underlying asset is experiencing an upward trend. This trend is characterized by higher swing lows and swing highs. Trend traders will enter a short position (sell) when an asset is experiencing a downward trend. This trend is characterized by lower swing lows and swing highs.
👉 It’s more common for day traders to follow a trend trading strategy but some specialize in contrarian plays. This is a trading strategy where a trader purposefully goes against the prevailing trend. In other words, these traders sell when others are buying and buy when others are selling.
Is day trading risky?
👉 Forex and stock trading are associated with risks and day trading is one of the riskier trading styles to adopt. This is because day traders rapidly buy and sell stocks multiple times in a single day with the aim being to make a profit from small fluctuations in price movements.
👉 Day traders typically trade on leverage. This means they borrow money to trade and hope to make enough money on multiple positions to pay back the money owed and make a profit. Leverage products magnify gains but they also magnify losses, meaning you can make more or lose more than you borrow.
👉 Day trading can be extremely stressful and there is the risk of severe financial losses. Day trading is best left to experienced forex and stock market traders who have the means to trade on leverage. These are typically day traders who work for large banks and brokerage houses.
👉 Day trading is extremely demanding of your time and should really only be done as a full-time career. Day traders watch the market continuously, looking for the slightest up and down movement on prices. It’s also not an exact science because the price fluctuations are so small that it’s impossible to apply fundamental analysis to the process.
How to start up as a day trader
👉 If day trading interests you, there are a few things you should know upfront before starting.
Understand the risks of trading on leverage
👉 Most day traders trade on leverage, either because they do not have the capital required for larger positions or they do not want to use their own capital to make profits.
👉 It’s important to find out what capital is required and what leverage is provided to trade intraday on the underlying assets that interest you. Avoid falling into the trap of trading out of your league.
Choose the right trading platform
👉 Day traders trade underlying assets through an online retail trading platform via an online broker’s server. The most popular trading platform for day trading is MetaTrader 4 (MT5) or MetaTrader 5 (MT5). MT4 is designed primarily for forex trading whereas MT5 offers traders access to a broader range of financial instruments.
Find out how much it will cost you to trade intraday
👉 Brokers charge commission and transaction fees and these add up when trading intraday. Find out exactly what day trading will cost you before you commit to this trading style.
Develop a sound trading strategy
👉 It takes time, patience, and discipline to develop the right trading strategy that suits your trading style.
👉 If you are a beginner day trader, you have the option of using something like CopyKat to copy the trades of professional traders. You simply select a successful trader(s) you want to follow and either follow their trades and copy them manually or simply copy them automatically with the CopyKat feature.
👉 When the professional day trader opens a position, your trade order is automatically activated. Likewise, it’s closed when the professional closes his or her trade. If the professional trader makes money, you make money. And the opposite applies, you lose money when they lose money.
Start using a free demo account
👉 Don’t be lured by the promise of easy money on day trading. It’s one of the riskier trading styles and people lose a lot more money day trading than they make profits.
👉 The practice is key to becoming a successful day trader. The best way to practice without the risk of losing any money is by signing up for a free demo account through an online retail broker.
👉 A day-trading simulator (demo account) helps you develop confidence and gain the knowledge to make the best trading decisions. Remember, day trading involves buying and selling assets rapidly and a multitude of times in a single day. It requires discipline and nerves of steel to make a success of it.
👉 Demo accounts are free and you don’t use real money to execute trades. Demo accounts allow you to familiarise yourself with the charting tools and indicators, buy and sell currencies or stocks and practice using risk management tools such as Stop-Loss and Limit Orders; all without the risk of losing any of your own money.
👉 With enough time and practice, you’ll develop a sound trading strategy. Only once you have been able to make a profit for several months using a demo account, is it wise to open a live trading account with real capital.
Choose a broker
👉 Choosing a broker is one of the most important things you’ll do when you set up to become a day trader. You need to align yourself with a reputable online retail broker you can trust and who will guide you on your day trading journey.
👉 You also need to find out upfront what the broker charges in commission and transaction fees. Find a broker who offers competitive fees coupled with excellent service and reputation.
👉 Find out what trading platform is available through the broker’s server. The majority of forex trading is conducted through MetaTrader 4. Traders who trade in a wider scope of financial assets are migrating to MetaTrader 5.
Forex Trading Africa Disclaimer
Day trading in South Africa is associated with high risks and can lead to investors and traders losing a significant amount of money. The information in this article should only be used to educate yourself on how day trading works and the pros and cons of day trading on the forex and stock markets.
Pay due caution to the risks involved in day trading and take the necessary precautions to avoid losing money in intraday transactions.