Day trading is one of many ways to try to profit from moves in markets, like the stock market or currency market. Day trading sometimes gets a bad reputation because it runs counter to the principle that you should “buy and hold” your investments for long-term gains, rather than trying to time the market for short-term gains. Day trading is generally best left for professional traders who have capabilities beyond most average investors. Day trading can lead to significant profits, but it can also result in rapid losses. Here’s a quick look at the ins and outs of how to day trade.
What Is Day Trading?
Day trading refers to the buying and selling of stocks over an extremely short time frame. A day trader will never hold a position overnight, and this holding period can be as short as a few minutes or even a few seconds. The idea behind day trading is that very small profits can be garnered in a very short time span, without putting large amounts of capital at risk. As soon as a position turns negative, most day traders are out; similarly, as soon as a profit is generated, most traders typically sell.
One related alternative to day trading is swing trading, in which investments are held for a few days or weeks. Traditional “buy-and-hold” investors, on the other hand, maintain positions for months or years.
How to Start Day Trading
To start day trading stocks, you’ll have to open a brokerage account, just like any other investor. However, you’ll face additional restrictions if you begin day trading. For starters, if you’re flagged as a “pattern day trader,” you’ll be required to open a margin account.
According to the Financial Industry Regulatory Authority, if you make four or more day trades within five business days, you’re considered a pattern day trader. Once you acquire this label, day trading rules require you to maintain a minimum account balance of at least $25,000. If your account falls below $25,000, you’ll be restricted from making day trades.
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Day Trading Taxation
If you can qualify with the IRS as a professional trader, you can deduct any expenses related to your trading, such as computers, software, home office expenses and others. You can also make a “mark-to-market” tax election that can help you avoid tax traps such as wash sales. Bear in mind that most amateurs cannot qualify as traders using the strict IRS rules.
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Day Trading Tips
Whenever you buy or sell stocks, there’s a trader out there betting against you by taking the other side of your trade. As a day trader, this other party is often a computer algorithm or a well-funded institution. If you want to succeed in that type of market, you’ll need to be armed with the same or better information, and the ability to act quickly. Day trading is best undertaken using only risk capital that you can afford to lose.
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