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what is day trading

What is Day Trading and How Does It Work?

“What is day trading?” is among the top queries on Google when it comes to trading-related terms. The reason is quite apparent – it is the most popular and highly-profitable form of trading activity. Day trading isn’t for everyone, however. It requires specific skills and strong discipline. While the skills can be obtained via online resources, books, and courses, the lack of discipline is what fails the majority of beginner traders.

If you intend to join the world of financial markets, it is crucial to get familiar with the most popular trading style by understanding what day trading is. Once you lay the foundations, it is essential dive deeper in the mechanics of the process and find out how trading works. That way, you will be able to make a well-informed decision on whether you should try it. To shape your opinion and get a realistic picture of the associated risks and the rewards, it is essential also to take a look at the pros and cons of day trading.

Table of Contents:

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What Is Day Trading?

Day trading is a form of active trading where the trader buys and sells securities multiple times within one trading session. Day traders open and close a number of trades per day. Their strategies are focused on making profits from the intraday price changes.

Their main principle is never to carry open trades overnight. All positions are closed before the trading day concludes.

This type of trader employs a variety of trading strategies, designed to take advantage of intraday price swings. These include arbitrage trading, scalping, high-frequency trading, and more. They mainly rely on technical analysis tools, but often also trade the news. Another key characteristic is that they often use high amounts of leverage.

Day traders prefer highly liquid assets so that they don’t risk being locked in a trade. They can be seen trading on all markets, but the most popular ones are forex, futures, and stocks.

“Take your profits or someone else will take them for you.”
– J.J. Evans

Although many people think that day trading was introduced after computers and the internet revolutionized our world, the truth is that it has been around since the 1860s when telegraph communication technology was used to create the first ticker tape. It became mainstream, however, with the introduction of electronic communication networks.

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How Does Day Trading Work?

As its name suggests, day trading works by buying and selling stocks or other instruments continuously. All trades are placed and finalized within a single trading day. As a form of risk management measure, day traders avoid having open trades overnight, so that they don’t suffer from price changes they can’t react to.

Traders who operate manually usually execute 5 to 8 trades per day. Those who rely on automated trading systems can execute dozens or even hundreds of trades within one day. When traders aren’t buying or selling, though, they are focused on monitoring different markets, analyzing trends, reading research and analyst notes, looking for news, or communicating with peers.

To understand how day trading works, it is important to also look at the average length of the period traders hold the instruments they are buying. The average time generally ranges from a few minutes to no more than an hour. However, in many cases, traders sell their assets even before the first minute. So, what this means is that day traders rarely remain passive.

It is also worth noting that day traders can operate on multiple trading venues simultaneously. Those trading on one venue seek to profit from the price movements of one or more assets. Those who buy and sell on multiple exchanges at the same time try to capitalize on the price discrepancies between them and the arbitrage opportunities they result in. These situations, however, are short-lived. At some point, the price of the instrument evens on all venues.

Day traders’ preferred instruments share the following similarities – high liquidity and volatility (to be able to profit from the intraday price changes), low transactional costs, an opportunity for margin trading, and rich available information. That is why this type of trader favors forex the most, followed by futures and stocks.

Unsurprisingly, the most popular forex trading pairs are the seven leading ones, which comprise 85% of the global transaction volume – EUR/USD, USD/JPY, GBP/USD, AUD/USD, NZD/USD, USD/CAD, and USD/CHF.

How to Start Day Trading?

Considering there are over 1 billion searches on the topic, it can be a pretty daunting task to find out how to start day trading. The truth, however, is that this abundance of sources doesn’t equal tons of unique information and valuable know-how. In reality, just a tiny bit of this ocean of information is worth your attention.

The reason for the growing interest in the topic, for the most part, is because day trading can be a pretty lucrative career if one knows what they’re doing. Whether it’s working for a big institution or retail trading on their own, the traders practicing it can make a decent profit that greatly surpasses the average salary.

However, this doesn’t mean that they can’t go bankrupt in just a day. It can easily happen if they aren’t well aware of the risks or lack self-discipline. Especially when trading on leverage.

To understand how to start day trading, here are the most important steps you should follow:

1.) Take A Look In The Mirror

Every great professional endeavor starts with a self-assessment. To find out whether you can become a successful day trader, you should be honest with yourself and admit whether you possess what it takes in terms of knowledge, skills, psychological profile, and more.

While skills and knowledge can be obtained easily, you must consider whether you have the discipline and capability of taming your emotions and following your trading plan. The regular day trading session will present you with tons of false or deceiving signals, and you should be able to acknowledge them and avoid making rushed decisions.

This type of trading activity is a high-pressure one and requires the right mindset.

“If you can learn to create a state of mind that is not affected by the market’s behaviour, the struggle will cease to exist.”
– Mark Douglas

A University of California, Berkeley study points out that 80% of all day traders quit within the first two years, while only 7% remain after the fifth year. What this comes to show is that day trading isn’t for everyone. Many traders go bankrupt or can’t withstand the pressure to keep up in the long-term.

2.) Resource Estimation

Consider time and money as factors from critical importance.

Even if you don’t plan on day trading for a living, to be successful, you will still have to dedicate the necessary time. For most of your trading sessions, you won’t be able to leave your desk as you risk missing signals, price-moving news, or other essential factors.

Day trading doesn’t guarantee quick or easy profits overnight, but it does require having a respectable amount of capital to start. A trader with $15,000 in his portfolio has the better potential to succeed than one with $5,000. If you don’t have enough capital, you won’t be able to withstand the losses, which are an inevitable part of the whole process.

Bear in mind that, on some days, you may be on the losing side of 90% of the trades and make a profit on just 10%, which may still be sufficient enough. However, if you can’t handle the initial series of losses, you won’t reach the point where your strategy earns you money.

3.) Take Your Time And Be Persistent

Like any other field, the path to mastering day trading is lengthy and requires substantial knowledge and skills. The good thing is that there are plenty of resources for you to dive into in and learn from. There are so many courses, books, guides, tutorials, videos, and so on to get you going that you may end up confused about how and where to start from.

To avoid that situation, make sure you come up with a learning plan. It should include everything from learning how markets work and the characteristics of the different asset classes, through the different types of market analysis and the specifics of traders’ psychology, to researching platforms and tools that can help you in your day trading activities.

A great starting point to learn more about trading is Earn2Trade’s Beginner Crash Course. It is a 62 lesson trading course that also comes with an additional 100 recorded webinars, covering over 50 hours of content. The best way to take advantage of it is through the Gauntlet Mini™ program – an intraday futures trading exam that, upon successful completion, guarantees a funding offer for a live trading account by Earn2Trade’s trading partner. That way, even if you are a trader who lacks the capital to start, you can partner up with a proprietary trading firm and kick-off your trading career.

You can also complement your knowledge with books like “The Psychology of Trading” by Brett Steenbarger and “Trade You Way to Financial Freedom” by Van Tharp.

4.) Come Up With A Trading Strategy

A trading strategy is more than just “buy low, sell high”. It contains a clear plan about what assets to trade, when to buy and where to sell, how often to trade, how much capital to allocate for each trade, the desired goal, and so on.

There is no better way to describe the importance of having a day trading strategy in place and adhering to it than the following quote:

“I know where I’m getting out before I get in.”
– Bruce Kovner

The truth is that often, your strategy will fail. And that is okay.

Think of a basketball match, for example. Coaches’ strategies are based on hours of preliminary research and video analysis, but also are fine-tuned and adapted once the game gets going. Depending on the circumstances, the coach can even switch between entirely different strategies.

The case with day trading is the same – you should have one or two strategies that you have tested plenty of times before jumping in with real money. That allows you to fine-tune, adapt, or switch between them depending on the particular market situation.

The most important thing, however, is to apply only time-tested trading strategies and have an end goal that you aim for. Abandoning everything in the middle of a trading session to go with the general market sentiment or to take advantage of a short-lived opportunity is a recipe for disaster.

5.) Start With A Demo Account

Even if you have some experience with other trading activities (active trading, swing trading, etc.) and decide to switch to day trading, don’t risk starting with real money. The professional swing or active traders reading this may feel a bit intimidated or underestimated, but the reality is that, due to its mechanics, day trading requires a kind of a different money management strategy.

Consider the following situation – let’s say that our backtested strategy results in 60% success. This means we will be losing money on four of every ten trades.

But what if these 40% unsuccessful trades cost us more than the 60% winning ones? How much of our capital should we allocate to each trade? Or what about if three or four losing trades take place in a row and put our discipline to the test? Questions like these should be answered on the training ground.

“It’s not whether you’re right or wrong that’s important. It’s how much money you make when you are right and how much you lose when you are wrong.”
– G. Soros

Demo accounts are the best place to fine-tune a trading strategy, test your discipline, and shape your behavior. Earn2Trade’s Gauntlet Mini™ program, for example, offers a great way to dip your toes into the water. You can choose a demo account that corresponds with your needs. Choose the amount of virtual money you want at your disposal (options starting from $25 000 and up to $150 000 are available) and take your first steps into the trading world with minimal risk.

Last but not least, don’t forget that trading opportunities will always be there. The money lost, however, cannot be brought back. That is why you should start gradually and follow your plan.

Pros And Cons Of Day Trading

Day traders think of it as the “Holy Grail” of trading. Long-term investors and more conservative traders don’t fancy it so much. The truth is that as polarizing as it may be, this type of trading activity has its proven benefits and risks. Take a look at each one of the pros and cons of day trading to shape your opinion and complete your understanding:

Day Trading Pros

  • High-profit potential

The returns of the best day traders can make investment bankers jealous. Considering the compounding effect and the accumulation of capital over time, it means good day traders can become even better as their investment margin expands. Even if you aren’t among the best in the niche, you can still make a pretty decent living from it. Just be careful with the leverage.

  • Universal application

This type of trading activity can be applied to all asset classes – from forex, stocks, and futures, to options, cryptocurrencies, and more. This means experts in particular fields can quickly switch to day trading and apply their knowledge for their own good. More advanced traders often trade two or more asset classes at the same time, expanding their investment horizon and scaling their returns.

  • Transferable skills

If you manage to master day trading, it means you are capable of doing technical analysis, trading the news, performing backtesting, navigating the markets under pressure, being self-disciplined and adhering to your initial plan. It also means you are an expert in at least one asset class, which makes it easier to switch to other types of trading activities or engage in long-term investing.

Day Trading Cons

  • High trading costs

Due to its nature, day trading is associated with higher trading costs when compared to swing or position trading. It is one thing to pay a commission on two trades and quite another to be charged on the basis of 8 or 10 deals per day. To mitigate the trading costs, day traders usually seek out brokers offering tight spreads and lower trading fees.

  • High risk

Understandably, the potential of reaping high profits comes hand-in-hand with the risk of suffering significant losses. Because day trading takes place in highly-volatile markets, as well as the fact that it predisposes margin trading means that, without the proper risk-management strategy in place, one can have their whole portfolio wiped out in just a few trades.

  • Harder and more stressful

As we mentioned above, day trading requires a lot of skill, composure, discipline, financial knowledge, persistence, and more. It also tests the nerves of traders on a daily basis. Regret over missed trading opportunities or cracking under the mounting pressure when the end of the trading day is approaching because you still have positions to close can be pretty challenging for some traders. Aside from that, due to their shorter span, day trading sessions can involve much more market noise.

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