Day trading is buying or selling stocks typically in a one-day period with the intent to take advantage of short-term market fluctuations and make a profit. Using technical analysis, day traders identify price movements in the market and trade accordingly.
Day trading used to mostly be an institutional or professional investor strategy. However, the advent of online and app-based stock brokers has made day trading seem more accessible to retail investors. But because of the high knowledge and discipline it takes to be a day trader, many run the risk of significant loss if they’re not careful. Therefore, it’s not suitable for everyone.
Here’s how day trading works, the risks and more.
How does day trading work?
Day trading involves buying and selling securities within a single day in order to profit from short-term price changes. A day trader may buy and sell the same stock multiple times in a day, or use margin trading to amplify potential profits.
There’s no one fixed way to be a day trader as there are a variety of strategies day traders use including arbitrage, swing trading and news trading.
It’s worth noting that day trading carries a high level of risk and is not for everyone. Due to the high risk and high paced nature, day trading can lead to significant losses if traders are not careful or disciplined. It’s important to educate yourself on the risks before getting started.
What is a pattern day trader?
A pattern day trader is a person who executes four or more trades within a five business day period, according to the Financial Industry Regulatory Authority (FINRA), which oversees firms and brokers in the U.S. The number of trades executed in the five day period must also represent more than 6 percent of your total trades in the account. If a trader meets these regulations, they will be subject to additional regulations and requirements set by FINRA.
How much money do you need to day trade?
Pattern day traders must also maintain at least $25,000 in equity in their trading accounts at all times. The $25,000 is required prior to any day trading and you can’t meet the requirement by cross-guaranteeing separate accounts. Failure to meet these requirements may result in a closing of the trader’s account or implementation of restrictions. Day traders must understand the regulations and maintain the account balance accordingly.
Keep in mind, some broker-dealers may require clients to have a higher minimum equity level to trade.
What are the risks of day trading?
Day trading is complicated and sophisticated, which can lead to overconfidence among uneducated and inexperienced investors. It’s important to note that day trading is not a get-rich-quick scheme, as it can result insubstantial losses.
It can also be costly, with a potential minimum equity requirement of $25,000 and higher. Although many brokerages have shifted to zero-commission trades for stocks, options trading typically still comes at a cost.
Taxes are another consideration. For any investment you hold for a year or less, you’re subject to short-term capital gains. You may be able to offset gains with capital losses, but you’re still subject to the tax if you day trade.
Lastly, day trading is volatile and requires a level of speculation and market monitoring that favors professional traders rather than retail investors.
For the casual investor, day trading is likely not the wisest financial decision. However, if you’re experienced, have a broker with reasonable commissions and understand the risks and volatility of day trading, you could potentially increase your investment gains. That said, it bears repeating that most financial experts agree that long-term investing is the lowest-risk way to build wealth.