Key Takeaways
- Day trading involves buying and selling securities during the same day to capitalize on short-term price movements using technical analysis and fast decision-making.
- Day trading carries high risk, and only a small percentage of retail traders consistently make a profit.
- Successful day traders may use strategies such as defined trading plans and limit losses with stop-losses.
- Pros often say that traders should never risk more than 1% to 2% of their capital on a single trade.
If you’re interested in day trading, you’re not alone, and you wouldn’t be the first to find out it’s way harder than it looks. In this guide, the MarketWatch Guides team will cover the basics of day trading — including the significant risks.
How Does Day Trading Work?
Day trading entails buying and selling securities, such as stocks, options, foreign exchange or cryptocurrencies, on the same trading day to try to make a quick profit. Unlike long-term investing, day trading attempts to capitalize on news cycles, market inefficiencies or small price movements in securities using technical strategies and real-time decisions. If you’re interested in joining the world of day traders, be prepared for the very real risks of losing money.
“You need to be fully comfortable with losing money and only use capital you can afford to lose,” Mark Johnson, a faculty fellow in investments and portfolio management at Wake Forest University, told MarketWatch Guides.
“It might seem exciting, but it’s stressful,” he said. “I think of a quote by Morgan Housel: ‘Risk is what’s left over when you think you’ve thought of everything.’”
Professional day traders, or institutional investors, tend to be employed by large financial companies with substantial resources and sophisticated financial software. Individual day traders, known as retail traders, must spend significant time researching, learning and understanding day-trading strategies to stay on top of market data and industry news.
Day Trading vs. Investing
Day trading is fundamentally different from long-term investing. Day traders focus on exploiting short-term price changes to make quick profits. They rely on technical analysis of stock prices, charts and real-time news to make quick decisions. To avoid the risk of price fluctuations that may arise from late-night or early-morning news, most day traders don’t keep stocks overnight.
But long-term investors are focused on the value of a company. They research businesses, diversify their portfolios and stay invested through market fluctuations.
“Day trading risks are usually higher than long-term investing because you’re dealing with very short-term market moves,” Justin Haywood, a certified financial planner and co-founder of Haywood Wealth Management, told MarketWatch Guides. “With long-term investing, you’ve got time to recover from bad days or weeks, but day traders don’t have that luxury.”
How Do Day Traders Try To Minimize Risk?
In day trading, managing risk may ultimately be more important than finding the perfect strategy. Even successful institutional day traders who manage investments for other entities lose on many trades. But they try to limit their losses.
Creating a Trading Plan
A trading plan is essentially a day trader’s guide book for when to enter the market, when to exit, what to trade and how much to trade. Following a plan can help decrease emotional reactions to market events outside of that strategy. With this plan, a trader creates a watchlist of positions they’re interested in that adhere to their trading criteria. These function as signals for when it’s time to execute a trade.
Setting Stop-Losses and Profit Targets
Stop-loss orders can help day traders limit their losses by automatically selling stock if it drops to a predetermined price. For example, if a trader sets a stop-loss order on their GameStop position to $21, it would trigger an immediate sale if the GameStop price dropped to $21, limiting potential losses.
A profit target is a predetermined price where a trader will sell and lock in a profit. Profit target orders help traders remain disciplined when selling and reduce the risk that they hold a position for too long.
Position Sizing and Risk per Trade
One rule experienced traders use to limit the impact of losses is the 1% to 2% rule. This means that if someone is trading a $10,000 portfolio, they’ll spend no more than $100 to $200 on a single trade. Another way to apply the rule would be by using stop-loss orders. If someone had a $10,000 trade, they’d exit the order when the loss equaled 2%, or $200.
What Are the Requirements for Day Trading?
To minimize risk, day traders need to be prepared financially, technologically and logistically. It’s important to set up a strong foundation before risking real money.
Choosing a Brokerage Account
A brokerage account used for day trading should have low fees to trade on margin, which is when a broker lends an investor cash to buy securities and then uses the account as collateral. For example, Robinhood charges 4.7% to 5.75% to trade on margin, while Fidelity’s rates start at 8.25% or 11.325%, depending on the customer’s debit balance.
The firm should also offer fast execution and helpful and intuitive platforms.
“Thinkorswim is one of the better platforms I’ve seen, especially for charting and trade execution,” Mark Johnson said. “I always recommend starting with a simulator and backtesting any strategy before committing real money.”
Essential Tools and Technology
Day traders need software that allows them to analyze data and monitor their positions in real time. While this type of technology can be expensive, it’s an integral part of day trading. Some software can even integrate with the user’s brokerage, helping them make trades seamlessly.
A high-speed internet connection is also non-negotiable — even a slight delay can mean piling up losses or missing out on profits. Traders use charting tools to help identify price patterns and signals for entry or exit points, while real-time data feeds deliver up-to-the-second market movements.
Capital Requirements and Pattern Day Trader Rule
Depending on how much a person trades, they may be required to open a margin account and fund it with a certain balance. In the U.S., traders who execute four or more day trades within five business days in a margin account are considered pattern day traders by the Financial Industry Regulatory Authority. Pattern day traders are required to maintain a minimum of $25,000 worth of cash or securities in their accounts before they’re allowed to make trades on a particular day. This is to ensure they’re able to repay any losses in their margin accounts if trades lose money.
Smaller traders who don’t trigger the PDT rule should still keep enough money in their accounts. This money acts as a buffer to help them absorb losses and avoid being forced to sell at unfavorable times or having a string of losses wipe out their accounts. Also, every trade will likely cost a commission, spread and other fees. For those trading with only a small amount of money, these fees will make up a larger proportion of their account, making it more difficult to turn a profit.
Understanding Charts and Indicators
Technical analysis is a core tool for day traders. They need to be familiar with the basics of price charts and technical indicators to successfully execute many common day-trading strategies.
Reading Price Charts
A price chart shows a stock’s movement over time and helps traders identify entry and exit points. Typically, price charts are line charts, bar charts or candlestick charts. Candlestick charts are often used for trading because of the enhanced information they provide. Candles have red or green bodies to help traders visualize the range between the stock’s opening and closing prices and whether the stock’s current price is higher, which is in green, or lower, which is in red, than its opening price.
The volume of trades for a stock is shown by the vertical bars below the price chart, with each bar representing the total volume traded during a specific time frame. Traders can set longer time frames, such as one hour or one day, or shorter time frames, such as one, five or 15 minutes. One-minute charts are used with strategies such as scalping, while five-minute charts can be used for momentum or range trading, which we explain later in this guide.
Popular Technical Indicators
Several technical indicators can simplify trading decisions by offering insights into trend direction, momentum and potential entry or exit points.
- Moving averages: This indicator helps identify trend reversals or confirm trend strength.
- Relative Strength Index: RSI ranges from zero to 100 and measures how overbought or oversold a stock is.
- Moving average convergence divergence: MACD is an indicator used to reveal changes in stock price trends.
- Volume weighted average price: This indicator shows the average price a security has traded for throughout the day, weighted by volume.
Common Day Trading Strategies
While none of the strategies below can guarantee a profit — and may result in significant losses — day traders commonly use them to spot opportunities and manage trades, often buying and selling the same stock multiple times during the day.
Momentum Trading
Momentum trading is a strategy where traders try to identify trends in the price of a specific security and predict its short-term future price. Traders pay attention to when a security’s price falls and then determine the best time to sell if its price rises. Often, traders look for clues about future pricing through news reports or large-volume trades of the security. For example, if a biotech company announces positive results from a drug trial, a momentum trader could buy its stock as it begins to surge, riding the wave of high demand the announcement brings. As the price cools off minutes or hours later, they’d sell their position.
Scalping
Scalping is a high-frequency trading strategy that tries to capture tiny price changes in a stock. Scalpers may hold positions for a few seconds or minutes, buying a stock for $50.05 and selling for $50.12, for example, with the hopes that many small wins will add up over time. Because there are so many trades in a day, it’s extremely important to choose a brokerage with low fees. This strategy requires fast execution and constant attention.
Range Trading
Range trading involves determining a range for buying and selling a particular security. Day traders can set automatic orders to buy a position if a stock price falls to a predetermined level, such as $30 (known as a level of support) and sell if it reaches a certain limit, such as $35 (a level of resistance). Tools such as the Relative Strength Index and Stochastic are technical indicators used in range trading to measure the momentum of a stock’s price and identify when it could be overbought or oversold.
FAQ: Day Trading for Beginners
While you can technically start day trading with $1,000, it’s likely not a good idea. You’ll generally need a much larger portfolio to absorb losses and pay commissions on your trades. FINRA notes that an investment of less than $50,000 can make it significantly more difficult to turn a profit in day trading and that “you should be prepared to lose all of the funds that you use for day trading.”
No, you don’t need a license to day trade in the U.S. or most other countries as a retail, or individual, investor. However, if you execute four or more day trades in a margin account within five business days and those trades represent more than 6% of your total trades, then FINRA considers you a pattern day trader. This requires you to maintain at least $25,000 in a margin account to continue to day trade.
With day trading, you probably won’t make much, if any, money. The vast majority of consistent day traders lose money. Competition and technology, such as high-frequency trading algorithms, have made it increasingly difficult to make money in this field. Statistically, you’re much better off investing in low-cost index funds such as an S&P 500 for the long term.
You’re probably better off trading stocks as a beginner since the market is large and active and most stocks are commission-free. With forex, you’ll generally need to trade on margin, which can be risky and expensive for beginners. Stocks are highly regulated in the U.S. and have investor protections that cryptocurrency doesn’t.
*Data accurate at time of publication.
*The content provided in this article is for informational purposes only and should not be construed as financial, investment or tax advice. You should consult a licensed financial adviser or tax professional before making any investment decisions. All investments carry risks, including the possible loss of principal. Past performance is not indicative of future results.