How To Day Trade: Your Guide
Literally speaking, day trading means buying and selling a security, usually a stock, within the same day. But with the speed of technology — and the insatiable appetite of traders to capture gains — day trading in the 21st Century often refers to traders rapidly moving in and out of securities within seconds.
Part of the appeal of day trading is the ability to capture gains quickly. You can also get started with a very small sum of money — whatever your firm’s minimum is to buy or sell a stock.
See: 3 Things You Must Do When Your Savings Reach $50,000
How Do You Start Day Trading?
If you’re looking to become a day trader, it’s imperative that you learn all of the ins-and-outs of this investment style, from various ways to do it to the pros and cons of the whole process. You’ll also have to learn the specifics of how to actually do it. Here’s an overview of what you’ll need to know.
Steps To Start Day Trading
1. Do Your Research
The first step to any kind of investing is to understand the market and the strategies you can use.
What Types of Securities To Choose
Although some day traders may focus on alternative investments such as commodities, futures or other exotic instruments, most focus on individual stocks. Not only is information more readily available on stocks, they are also among the most liquid investments available. As a day trader, an important factor in your success will be how easily you can move into and out of an investment.
For this reason, you’ll likely want to focus on the most liquid stocks — those that trade millions of shares per day. High-volume stocks tend to have the smallest spreads between the bid and ask prices, and that makes it easier to make a profit. If you try to day trade stocks with lesser volume, you might find it hard to execute a trade at the price and time that you want, and as a frequent trader, every single cent matters when it comes to your execution prices.
Specific Day Trading Methods
Although you can haphazardly day trade stocks in a random way, your best bet for success is to have a specific strategy. Delineating a strategy can help you maximize your gains while limiting your losses, and it helps to remove emotion from the equation. Here are some of the most popular and well-known methods to day trade stocks:
- Momentum Trading: Momentum traders simply buy stocks that are already moving up or sell stocks that are on the way down. The general principle is that a stock in motion tends to stay in motion, whether up or down.
- Technical Trading: Technical day traders use charts to select the stocks they will buy or sell. If a stock breaks out of a recent trading pattern, for example, it becomes a buy for a trader. Similarly, if a stock falls out through the bottom of a recent trading range, it becomes a sell.
- Range-Bound Trading: A range-bound trader will sell a stock when it reaches the top of its recent trading channel or buy it when it’s at the low of the range. As many stocks remain range-bound rather than breaking out of recent trading patterns, there can be more stocks available for this type of trading.
- Scalping: This strategy relies on the power of small profits to add up over time. A trader will buy and sell rapidly, often within seconds, to capture very small movements in a stock. By the end of the day, a trader may have made literally hundreds of transactions in a single stock, pocketing small individual profits that become large ones over time — when successfully implemented.
It’s a good idea to learn the ropes of day trading without risking your actual money. You can set up a demo account on various platforms, like Webull and eToro.
2. Understand the Risks and How To Manage Them
Many day traders feel that their style of investing actually reduces risk, as they don’t hold investments overnight when adverse news can move the price of a security while the market is closed, preventing them from getting out and avoiding a loss. While this part of the theory holds true, day trading strategies can also carry a large amount of risk.
Day trading seems great when you’re on a roll and taking profits, but it’s inevitable that a significant amount of your day trades will be unprofitable, even if you’re a successful trader. When those losses start to pile up in rapid succession, it can trigger an emotional response that takes you away from your basic day-trading strategy.
Letting your emotions cloud your judgment is one of the primary risks of day trading — but it can be limited if you adopt a strict adherence to your day-trading policy.
Another major risk of day trading is that you might simply lose your entire bankroll, or at least a significant portion of it. This is why a day-trading strategy and a stop-loss policy is of paramount importance. By limiting your losses, you’ll live to invest another day, but if you let them run — or worse, pour more money into a losing trade — you might find you’re out of money faster than you could imagine.
Diversify Your Portfolio
It’s important to view day trading as a speculative offshoot of your primary portfolio rather than your entire investment strategy. The amount of stress and risk involved in day trading your way to a retirement nest egg is incalculably high.
But if you invest the bulk of your portfolio in “boring” long-term investments, you can use a small percentage of your overall capital for day trading. That way, even if you blow yourself up day trading, you’ve still got most of your assets building your long-term net worth.
3. Choose a Brokerage or App
Once you understand the market, have a strategy and know the risk you’re about to undertake, you’ll need an account to start trading. When you choose a brokerage or app, you’ll need to consider a few factors:
- Fees and commissions: You don’t want all your gains going toward paying fees for using the platform.
- Transaction speed: Day trading requires quick thinking and quick processing, so choose a platform that will execute your trades in seconds, not hours.
- Tools and customer service: If you run into a problem, you want a platform that can solve it quickly.
4. Don’t Forget About Your Taxes
It can be hard to think of it when you’re in the middle of the action, but each day trade you make is a separate, reportable transaction to the IRS. Needless to say, each profit you take while day trading will be short-term in nature, meaning you’ll pay ordinary income tax on your profits rather than the more favorable long-term capital gains tax rate.
If you’re in a high tax bracket, this could take a significant bite out of your day-trading profits.
Can You Get Rich Day Trading?
Day trading is not for the faint of heart. In addition to requiring a significant amount of time, it also carries the risk of losing your entire bankroll. In fact, studies have shown that only a very small percentage of day traders actually make money over the long run.
However, with discipline, focus and a certain level of skill — and perhaps a dash of luck — day traders can earn big profits. Just be sure you have the temperament to handle the high-stress world of day trading, and that you’re only risking money you can lose to do it.
FAQHere are some answers to common questions about day trading.
- How much money do you need to day trade?
- You'll need a minimum of $25,000 in your account to be "pattern day trader" – meaning you have at least four day trades within five business days – by FINRA regulations.
- How much do day traders make?
- There is no guarantee or usual amount that day traders make. For example, ZipRecruiter reports an average income of $76,989 per year for day traders in the U.S., while Zippia reports $116,895 as the national average – a huge variation.
- Realistically, you need skill and luck both to make either of those numbers.
- Is it possible to make $100 a day through day trading?
- It is possible to make $100 a day through day trading with enough starting capital and successful trades, but again, day trading is high risk, so you may lose that money instead.
Amber Barkley contributed to the reporting for this article.
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- U.S. Securities and Exchange Commission. "Pattern Day Trader."
- Zippia. "WHAT IS A DAY TRADER?"
- ZipRecruiter. "Day Trader Salary."