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What is Day Trading?

What is Day Trading?

Postby admin » Thu Oct 04, 2012 8:25 pm


Day trading refers to the practice of speculation in securities, specifically buying and selling financial instruments within the same trading day, such that all positions are usually closed before the market close for the trading day. Traders who participate in day trading are called active traders or day traders. Traders who trade in this capacity with the motive of profit, assume the capital markets role of speculator.

Not widely known, the correct definition of an "intra-day" means the move as measured from the previous close and not just relative to another price traded on the same day.

Some of the more commonly day-traded financial instruments are stocks, stock options, currencies, and a host of futures contracts such as equity index futures, interest rate futures, and commodity futures.
Day trading used to be an activity that was exclusive to financial firms and professional speculators. Many day traders are bank or investment firm employees working as specialists in equity investment and fund management. However, with the advent of electronic trading and margin trading, day trading has become increasingly popular among at-home traders.

Trade frequency
Although collectively called day trading, the practice contains many styles with specific qualities and risks. Scalping is an intra-day speculation technique that usually has the trader holding a position for a few minutes or even seconds. Shaving is a method which allows the scalping speculator to jump ahead by a tenth of a cent, and a full round trip (a buy and a sell order) is often completed in under one second. Instead of bidding $10.20 per share, the scalper will jump the bid at $10.201, thus becoming the best bid and therefore the first in line to be able to purchase the stock. When the best "Bid" is $10.21, the shaver will again jump first in line and sell a tenth of a cent cheaper at $10.209 for a profit of 0.008 of a dollar. The profits add up when using 10,000 share lots each time and the combined earnings from Rebates (read below) for creating liquidity. A day trader is actively searching for potential trading setups (that is, any stock or other financial instruments that, in the judgment of the day trader, is in a tension state, ready to accelerate in price in either direction, that when traded well has a potential for a substantial profit). The number of trades one can make per day is almost unlimited, as are the profits and losses.

The price of financial instruments can vary greatly within the same trading day (screen capture from Google Finance).
Some day traders focus on very short-term trading within the trading day, in which a trade may last just a few minutes. Day traders may buy and sell many times in a trading day and may receive trading fee discounts from their broker for this trading volume.
Some day traders focus only on price momentum, others on technical patterns. Some traders choose to focus on an unlimited number of strategies they feel can be profitable.

Most day traders exit positions before the market closes to avoid unmanageable risks—negative price gaps (differences between the previous day's close and the next day's open bull price) at the open—overnight price movements against the position held. Other traders believe they should let the profits run, so it is acceptable to stay with a position after the market closes.
Day traders sometimes borrow money to trade. This is called margin trading. Since margin interests are typically only charged on overnight balances, the trader pays no fees for the margin benefit, though still running the risk of a Margin call. The margin interest rate is usually based on the Broker's call.

Profit and risks:
Because of the nature of financial leverage and the rapid returns that are possible, day trading can be either extremely profitable or extremely unprofitable, and high-risk profile traders can generate either huge percentage returns or huge percentage losses. Because of the high profits (and losses) that day trading makes possible, these traders are sometimes portrayed as "bandits" or "gamblers" by other investors. Some individuals, however, make a consistent living from day trading.

Nevertheless day trading can be risky, especially if any of the following is present while trading:
trading a loser's game/system rather than a game that's at least winnable,
trading with poor discipline (ignoring your own day trading strategy, tactics, rules),
inadequate risk capital with the accompanying excess stress of having to "survive",
incompetent money management (i.e. executing trades poorly).

The common use of buying on margin (using borrowed funds) amplifies gains and losses, such that substantial losses or gains can occur in a very short period of time. In addition, brokers usually allow bigger margins for day traders. Where overnight margins required to hold a stock position are normally 50% of the stock's value, many brokers allow pattern day trader accounts to use levels as low as 25% for intraday purchases. This means a day trader with the legal minimum $25,000 in his or her account can buy $100,000 (4x leverage) worth of stock during the day, as long as half of those positions are exited before the market close.

Because of the high risk of margin use, and of other day trading practices, a day trader will often have to exit a losing position very quickly, in order to prevent a greater, unacceptable loss, or even a disastrous loss, much larger than his or her original investment, or even larger than his or her total assets.
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