Day trading has been a controversial topic among investors and non-investors alike.
Day traders lament that their profession has been grossly misunderstood.
Many people have already formed opinions on it and avoid it like the plague – you might even be one of them.
Even people on Wall Street debate whether you can consistently make a profit or not through day trading. But what is day trading, and how does it work?
Today, you’ll be able to answer the question “what is a day trade?” after we go through a brief explanation of its history and controversy, pros and cons of engaging in day trading, and popular strategies day traders use to make a profit.
What is Day Trading: The Basics
First, let’s focus on what day trading is not. It's not traditional investing – the investment strategies you are probably familiar with – involves buying securities (stocks, bonds, options, etc.) with the goal of making a profit in the long term, usually after a number of years.
Day trading, on the other hand, focuses on short-term investments. Day traders buy and sell securities within the course of a trading day. They aim to sell their stock higher than what they bought it for before the day closes, and do this process all over again the next day.
Why Is It So Controversial?
What is it about day trading that earned its bad reputation?
In the 1990's, it was the talk of the town. People were quitting their jobs and turning to day trading to earn quick and easy money.
Most of these day traders invested in dotcom websites. And, you're surely aware, the dotcom bubble burst at the turn of the millennium, and the NASDAQ sank.
Day trading faded, and we didn’t hear about the topic for quite a while. Recently, however, day traders have emerged again, but the debate still persists.
Pros and Cons
For starters, the short-term environment of day trading has its advantages: you don’t have to worry about stocks suddenly plummeting overnight and thus you can avoid incurring huge losses as you’ve already made your transactions and closed your position at the end of the day. Long-term investments are vulnerable to sudden bad news, like criminal cases filed against a company, for example.
With the aforementioned reduced risk, however, comes a disadvantage: you can only choose or do so much within a day. Long-term investments, on the other hand, are equipped with market efficiency in the long run and with the time value of money.
It is also great for people who want to work independently, as most day traders are self-employed – they are their own boss. Like most self-employing jobs, however, it can be extremely stressful: you have to constantly watch fluctuations and analyze trends in the market (within a single day!) to earn a profit or at least break even.
Day traders say that their profession is an easy way to earn quick money, given that you use proper strategies and invest in the right markets. Dissenters argue, however, that it can be as addictive as gambling.
Day traders, like most entrepreneurs, should also be prepared to suffer capital losses, especially at the beginning. The U.S. Securities and Exchange Commission also issues a word of warning against claims of “easy profits” and “expert advice” advertisements on websites and newsletters.
Popular Strategies of Day Traders
Now that you know what day trading is, you might want to know some popular strategies day traders use to earn a profit:
1. Scalping. One of the more popular strategies in day trading, scalping involves relying on small price fluctuations. You hold the asset for a very short amount of time (around minutes or seconds), and sell it immediately when the price increases.
2. Momentum trading. This strategy relies on news trends – once a stock accelerates, momentum traders can invest, and sell when signs of reversal begin to show.
3. Fading. While momentum trading uses news trends and trend analysis, traders that employ fading go against the grain: they buy when the price is plummeting, and sell when it is increasing. This strategy is considered very high-risk, so this is only recommended for those who can handle its possible negative consequences.
In addition, day traders usually invest in one or two markets, usually in foreign exchange, stock, or commodity markets.
Essentials of Day Trading
Before engaging in it, make sure that you have the following:
1. Trend Analysis Software. Day traders rely on existing trends within a day, so it is necessary for them to invest in analysis software. You also need to invest in high-speed internet connectivity. Most of these tools, however, are quite expensive – which leads me to the next ‘essential’ of day trading…
2. A lot of capital. Leverage (borrowing capacity) is necessary to engage in day trading. Possible returns increase with more capital.
3. Discipline. As previously mentioned, dissenters say that it can be as addicting as gambling, which is why you will need a lot of discipline to resist impulsively buying from markets that can be quite volatile. Day traders also follow a strict plan, which usually involves stop-loss orders (selling at an established price level).
4. Knowledge and experience. Nothing beats knowledge and experience. One of the reasons a lot of day traders suffered huge losses in the 90s is due to their lack of basic knowledge and experience in trading.
Should You Go For It?
Day trading can be one of the most difficult things to do, but it can also be highly rewarding. Historically speaking, more day traders have lost money. However, if you have the skills, characteristics, and resources mentioned, plus are comfortable with risk, it just might be for you.