Day trading is an approach that focuses on buying and selling stocks, foreign currencies, commodities, cryptocurrencies, and other financial instruments within the same day. This allows traders to take advantage of the fast-paced trading world, where short-term trends can bring large profits. There is an appeal in day trading for beginners and experienced traders alike, as it offers many advantages over other trading strategies.
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Let’s take a deep dive into the topic and explore all aspects of day trading in detail.
What is Day Trading?
The primary goal of day trading is to capitalize on small price fluctuations in these assets and make quick profits. Day traders do not hold positions overnight; they close all of their trades before the market closes for the day. Some of the key characteristics of day trading include:
- Short timeframes. Day traders focus on short-term price movements, trading within minutes, hours, or holding the position all day. The trade is never transferred to the next day, which helps avoid any overnight commissions.
- High number of trades. Day traders prefer to exercise dozens of trades within the day, opting for smaller investment sizes. This allows them to hedge risks while adding up small profits to a large sum.
- Use of leverage. As mentioned above, day traders focus on short market movement and tend to invest small amounts, taking advantage of the leverage that brokers provide. This allows them to trade with a larger amount than they invested, and maximize the potential returns.
- Technical analysis and continuous monitoring. Most day trading strategies are based on technical analysis tools, indicators, chart patterns. Traders study historical data to draw conclusions about the possible price movements in the future. At the same time, traders closely monitor the market conditions to spot potential trades quickly.
Day Trading for Beginners
Day trading is an approach that requires skillful execution, which is why beginners in trading often shy away from it. This approach requires developing good technical analysis skills to spot entries, as well as mastering trading psychology to control impulse decisions. Since day trading is associated with high risk, there is a lot of studying and practice that beginners need to do to be good at it. Some traders choose the route of position trading, where trades are held for a prolonged period of time, and the risk is lowered.
Position trading has its benefits, however, keeping longer and fewer trades (a contrast to the day trading approach, where multiple trades are opened and closed within the same day) does not guarantee better outcomes. On the contrary, often traders are tempted to invest larger amounts into trades, and hold them over an extended period (for instance, several weeks). As a result, it is not uncommon for traders to miss the optimal exit time, losing their invested amount, or missing out on a larger profit. Day trading takes care of this aspect, since no positions are ever kept overnight.
No matter which route you select— short timeframes or longer trades, mastering day trading strategies will be useful, as they can help you improve on various trading skills and build up risk tolerance. As a beginner, you may familiarize yourself with the necessary terminology first, and then practice the day trading strategies on a demo account to get a hang of them and accumulate experience.
Key Day Trading Terminology
Understanding day trading and studying popular day trading strategies requires learning the key day trading terminology that is often used in the trading process. Let’s take a look at the most frequent terms that you may need to familiarize yourself with.
- Volatility: measures the degree of price fluctuations in an asset. Day traders typically favor assets with higher volatility because they offer more opportunities for trades.
- Liquidity: refers to how easily the asset can be bought or sold without affecting its price. Highly liquid assets have many buyers and sellers, making it easy to enter and exit positions.
- Stop Loss: opening many positions, traders need to rely on tools that could limit the potential losses. Stop loss is an order that can be placed to close the position in case it begins losing money.
- Risk-Reward Ratio: a measurement of the potential profit against the potential loss. A positive risk-reward ratio indicates that the possible gains outweigh the potential loss.
- Candlestick Chart: in most cases day traders choose candlestick charts over linear charts due to their functionality. Each candlestick represents the open, close, high and low for the chosen period, conveniently visualizing the data on the chart.
- Bull market: a prolonged period of rising prices, characterized by investors’ optimism towards the asset.
- Bear market: a prolonged period of declining asset prices, characterized by investors’ pessimism towards the asset.
Day Trading Strategies
There are numerous day trading strategies out there, and each has its pros and cons. The one thing they have in common is that they are exercised within the same day, and usually target short-term price movements.
Scalping
The main goal of this fast-paced strategy is to generate significant outcomes over multiple short trades with small profits. Scalping is considered a high-risk approach. It targets small movements, which allows for a high number of entries. Trades normally last from several seconds to several minutes, and the invested amount doesn’t exceed a couple of dollars. Making small moves allows scalpers to add up the profits over time, without risking a large investment amount at once.
The analysis side of scalping involves using trend-following indicators like the Moving Average, while also keeping an eye on the volume. Traders that exercise this approach can make dozens, and even hundreds of deals within one day, which requires a high level of discipline and self-control. Additionally, scalping requires a strict exit strategy because a large loss could eliminate any made profit.
Range Trading
Range traders identify specific price ranges or support and resistance levels within which an asset is trading. They buy near support levels and sell near resistance levels, expecting the price to remain within the established range. Range trading can be effective when markets lack a clear trend.
For example, if an asset is trading at $45, and the trader believes that it will reach $50, they conduct trades within that range until the target price is reached. Setting clear entry and exit points is important for this type of trading, and technical indicators, specifically oscillators, are often used to identify overbought/ oversold conditions.
Momentum Trading
Momentum traders focus on stocks or assets that are experiencing significant price movements with high trading volumes. They aim to “ride the wave” by buying assets that are rising and selling those that are falling. This strategy relies on the belief that strong price trends will continue in the short term.
This classic approach is considered a medium-risk strategy, as long as appropriate risk management tools are in place. The focus of a momentum trader is to spot the emerging trend and exit it before a reversal takes place. Momentum traders rely both on technical indicators and chart patterns to determine the direction of the trend.
Reversal Trading
Instead of riding with the trend, the reversal strategy attempts to identify potential reversals in the market. Reversal traders look for signs that an ongoing trend is about to end and may reverse direction. This strategy involves buying near the bottom of a downtrend or selling near the top of an uptrend.
To determine a reversal, traders use reversal chart patterns, as well as technical indicators, and graphical tools. Depending on the volatility, the asset may have more or less price reversals, and reversal trading is often used in combination with other strategies.
Advantages and Disadvantages of Day Trading
There are both pros and cons to the day trading strategy, and it’s crucial to familiarize yourself with both of them before choosing day trading as your trading method.
Advantages of Day Trading:
- Potential for high profits: day traders’ goal is to profit from short-term price fluctuations, which can bring significant gains if executed correctly.
- No overnight fees: day traders don’t hold positions overnight, which means they are not exposed to overnight fees, and their trades are not affected by gaps.
- Increased liquidity: day trading usually involves highly liquid assets, making it easier to enter and exit positions quickly without significant price slippage.
- Quick feedback: day trading provides rapid feedback on trading strategies, allowing traders to adjust their approaches and learn from their mistakes quickly.
- Fast-paced trading: day trading allows for fast trade execution, which can be exciting.
Disadvantages of Day Trading:
- High Risk: Day trading involves substantial risk, and losses can accumulate quickly due to the frequency of trades and leverage used.
- Time-Consuming: Successful day trading requires a significant time commitment, often requiring traders to monitor the markets throughout the trading day.
- Emotional Stress: The fast-paced nature of day trading can lead to emotional stress, anxiety, and impulsive decision-making, which can negatively impact trading results.
- Limited Diversification: Day traders often focus on a small number of assets, which can lead to a lack of diversification in their portfolios, increasing risk.
Conclusion
Day trading is an approach suitable for beginners and experienced traders alike. In day trading, deals are opened and closed within the same trading day, and different strategies are used to achieve profits. It requires careful planning and profound knowledge of trading markets because it is associated with high risk and may lead to losses if not exercised properly. There are pros and cons to day trading that need to be taken into consideration as well.
Have you tried day trading before? Tell us about your experience in the comments below!
