What Is Day Trading? Your Complete Guide To Starting
Day traders get their name from their style of investing. Instead of buying and holding, as per the advice of investment experts everywhere, they do the exact opposite. Day trading involves buying securities only to sell them a short time later — usually within a single trading day — in the hopes of locking in relatively small short-term gains that accumulate and compound over time.
It’s a risky game defined by big profits and steep losses. Retail investors — regular, nonprofessional individuals without access to corporate resources, software and data subscriptions — rarely make money over time as day traders.
The lure, however, is simply too much for some to resist.
Despite the long odds of success, the idea of ditching your 9-to-5 and financing your lifestyle just by moving numbers around on a computer screen a few hours a day is too enticing to pass up for many. If you’re considering entering the risky but exciting world of day trading, here’s what you need to know.
What Is Day Trading?
Day trading refers to the buying and selling of stocks over an extremely short time frame. A day trader will rarely 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 tiny 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, most traders typically sell as soon as a profit is generated. The term “day trading” can apply to both short sales and the traditional buying and selling of stocks.
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. The logic of buying and holding is that the inevitable short-term losses will be negated by long-term gains over time — but only for investors who resist the urge to sell when a stock starts losing value.
For novices and even moderately experienced investors, long-term investing is the most widely recommended strategy by far — and for good reason. Unlike day trading, the common investor can make buy-and-hold investing work with a little bit of research and luck.
Is Day Trading a Good Idea?
Publications like Forbes have reported a steep rise in day trading as free brokerage accounts and an incredible amount of research materials are now available to just about everyone with a laptop. Many financial professionals, who tend to look at day trading as gambling more than investing, see it as a disaster in the making.
How To Day Trade
To start day trading stocks, you’ll have to open a brokerage account, just like any other investor. Among the top low- or no-cost trading platforms are:
You should plan, however, to face additional restrictions once you get going. For starters, if you’re flagged as a pattern day trader, you’ll be required to open a margin account.
Trading on Borrowed Money Increases the Risk
A margin account is a special type of brokerage account in which the account holder borrows money from the brokerage firm to purchase securities. Although margin accounts allow investors to cash in when the stocks they buy on the margin appreciate, margin loans charge interest.
That means that losses are magnified dramatically compared to regular stock purchases because the borrower has to pay not only to make up for the losses on borrowed money but also to pay the interest charges.
How Much Do You Need for Day Trading?
In the era of no-fee online brokerages that offer fractional share investing with no account minimums, average people can start investing on even the smallest of budgets. On a lot of investing platforms, even a single dollar will do you.
Day trading, on the other hand, is a pay-to-play endeavor.
According to the Financial Industry Regulatory Authority, a pattern trader is “any margin customer that day trades — buys then sells, or sells short then buys the same security on the same day — four or more times in five business days, provided the number of day trades is more than 6% of the customer’s total trading activity for that same five-day period.”
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 and receive a margin call, which requires you to deposit more cash to meet the call.
Consider Starting With a Practice Run
Day trading is tricky and unfamiliar, and for most, it comes with a steep learning curve. Experts strongly — and wisely — advise newbies to start with a practice account where they can hone their skills in simulated day trading before they dive into the deep end of the pool without risking actual money.
You’re probably eager to get started in your new career making millions in your pajamas, but the learning experience of simulated, no-risk day trading can prove invaluable. If you’ve never done it before, you’ll need the practice. Some of the top day trading simulators include:
NinjaTrader
TradingView
eToro
How Much Does a Day Trader Make?
Typically, day traders are independent players with volatile and inconsistent earnings. Nailing down average or even general earnings is an imprecise undertaking. Comparably cites a sprawling range of $12,265 to $328,665 per year for an annual average of $63,689. ZipRecruiter cites a range of $11,000 to $253,000 for average annual earnings of $76,018 or about $37 an hour. Zippia estimates a much more generous median salary of $118,000 with the range starting around $72,000 and ending at around $195,000 for the top 90% of earners.
Can You Get Rich Doing Day Trading?
As you can see from the top salary and career sites, it’s certainly possible to make at least a comfortable living as a day trader — but can you get rich doing day trading?
Before the pandemic, day trader Ross Cameron wrote a widely cited post for Warrior Trading outlining how he earned more than $94,000 in just three months one summer. He averaged 200% gains trading just two hours per day — it’s the kind of story that makes newbies get into day trading in the first place.
Unlike so many “experts” who make wild claims that they expect to be taken on faith, Cameron backed up his numbers with official asset summaries from his brokerage and other documentation.
So, yes, it is possible to earn a whole lot of money as a day trader — but it’s much easier to lose.
When You Get in a Hole, It Can Be Hard To Dig Yourself Out
An ongoing discussion about day trading on the question-and-answer site Quora reveals a trap that many day traders don’t see until they fall into it. Even a few relatively small losses can quickly begin to compound, and the more they pile up, the harder it is to get back to neutral.
For example, say you have $100 and lose 20% in a series of bad trades, leaving you with $80. If you gain 20% the next day, you don’t have $100 again. You have $96. That’s because, on the second day, you didn’t gain 20% of your original $100. You gained 20% of the $80 you had left after losing the original 20%, which is only $16.
If you have $100 and lose 10%, you would need to gain 11.11% to get back to $100, not 10%.
As you can see, it’s very easy to build losing momentum.
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 under strict IRS rules. In the end, it’s all about capital gains — short-term gains like those earned by successful day traders are taxed at a much higher rate than long-term gains.
Day Trading Tips
Successful day traders lead enviable lives. No job. No boss. No schedule. No commute. However, the life offers no security or retirement plan beyond the next trade. If you’re ready to take the plunge, the following tips can get you off on the right foot.
Understand What You’re up Against
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 likely to be a computer algorithm or a well-funded institution.
In short, you’re competing against professionals in a highly competitive and crowded field. They’re often fighting for fractions of a penny per trade against other skilled pros. Just like card sharks at a poker table, the regulars salivate when a newbie joins the game.
Understand the Risks
One of the best things you can do is avoid going into it with illusions or delusions about the realities of day trading. If most people could get rich by day trading, most people would be day traders. The reality, according to CNBC and virtually all available data, is that you’re facing overwhelming odds.
Even buy-and-hold investors underperform the market a vast majority of the time when picking individual stocks. When it comes to pattern day traders, that number shrinks to a minuscule percentage of retail investors who make money consistently over time.
Although YouTube is full of videos made by “experts” ready to reveal the simple tips and tricks any novice can use to turn $1 into $1 million in no time flat, remember the adage: if it sounds too good to be true, it probably is.
If You’re Going To Do It, Do It All the Way
There is widespread expert consensus that day trading is a losing gamble for everyday investors, virtually all of whom would be better off sinking their money into an index fund. All experts, however, seem to agree that you stand essentially no chance if you treat it like a hobby.
The tiny percentage of amateur day traders who succeed over time have one thing in common: they treat it like a full-time job. If you dabble here and there, you’re essentially guaranteeing a loss. No matter how seriously you take it, never day trade with money you can’t afford to lose.
If You Do Dive In, Give Yourself the Best Chance at Success
There’s no denying that some day traders make a good living and lead enviable lives with no boss to answer to. If you’re confident after reading this that you have what it takes to join them, give yourself the best opportunity to succeed before you get started.
Aside from all the other expenses previously discussed, you would be wise to invest in analytical tools like automatic recognition software and genetic and neural applications.
Don’t allow overconfidence convince you that you’ll succeed because you have “a good head for numbers” or that “you can spot the trends.”
The professional, full-time traders you’re competing against are smart, too — and you can bet that they’re using sophisticated software to give them an edge.
The kinds of data subscriptions and software tools that you’ll need to succeed are expensive, but the losses you’ll almost certainly incur without them are bound to cost you more.
John Csiszar contributed to the reporting for this article.
Information is accurate as of Aug. 5, 2022.
This article originally appeared on GOBankingRates.com: What Is Day Trading? Your Complete Guide To Starting
