Day trading refers to the practice of buying and selling multiple stocks within a single day. It became a popular pursuit during the frenetic Internet boom of the late 1990s, when the emergence of online trading companies brought the stock market into every Internet-equipped home and office.
Differing from conventional stock trade, the net change of a stock’s price at the closing bell doesn’t control one’s profits or losses. Day traders’ gains and losses are determined by the price differences throughout the day; day traders must continuously monitor the prices of their stocks in order to capitalize on the ever-fluctuating differences between a stock’s sale and purchase price. This price gap is known as the spread.
Many financial advisors dissuade amateur investors against day trading, as it fails to offer the slow and steady rewards gained by long-term investing. Also, day trading occurs at such a furious pace — dozens of stocks can be bought and sold within a given day — that the commissions (the money you pay the broker for the sale) and spreads can add up and eat into your earnings.
The journals and Web communities devoted to day trading attest to the obvious risks involved, though the popularity of day-trading continues. Here are some basics to help orient you to this chaotic world and minimize its risks.
Practiced day traders employ various tactics in order to maximize their profit in this volatile venture. Here are some of their techniques:
- Playing the spread. This is perhaps the most popular approach to day trading. A day trader will sell the stock at its asking price and buy at the bidding price. Since there is always a difference between these two numbers — a.k.a. the spread — the potential for profit, even a miniscule one, is great.
- Playing the news. When a day trader “plays the news,” he buys or sells stocks from companies that have just released public announcements, have made the headlines, or have otherwise been in the news. Essentially, this trader will base his or her sales and purchases off of the latest newsworthy buzz and noteworthy publicity. If a company has just released a new and innovative product, buy before it peaks. If another company committed some public relations snafu, sell before it plummets.
- Counting on trends. On Wall Street and to a day trader, to follow a “trend” is to track those stocks whose rise or decline is steady, whose progress follows a trajectory. Stocks are bought and sold based on these movements, with the trader banking that the trend continues.
- Range trading. Range trading is similar to trading based on trends; in both scenarios, an understanding of a stock’s performance history is necessary. In this case, a trader follows stocks whose rise and fall fluctuates between certain ranges, stocks that rise on a support price and fall on a resistance price. Each time these stocks rise to a high, they will drop back to a low. Day traders will buy during the lows and sell again when the stock has hit its peak.
Five Day-Trading Tips
- Talk with a financial advisor. Before you begin day trading on your own, talk with a financial advisor about your long-term investment goals. Seek assistance in creating an investment portfolio, and discuss how much money you should allocate toward day trading. (Due to the inherent risks and typically lackluster payoffs, most financial advisors will tell you not to sink too much money into day trading.)
- Research the stocks. Investigate the stocks that you’re looking to purchase and sell, and consult Web sites solely dedicated to the art of day trading like Daytraders.com for advice on how to conduct your transactions successfully.
- Commit the time. Day trading requires a great deal of time and close attention. Be sure you’re ready and willing to monitor the near-perpetual shifts that occur moment to moment in the stock market. Moreover, you’ll need the nerve required to trade at a rapid clip.
- Go high-speed. Conduct your day trading online using a high-speed DSL connection, and sign up for online order execution through a company like eTrade.
- Start cautiously. When you embark on day trading, start by trading only two to three stocks on a small investment. Watch to discern and understand what factors push and slow their price progressions, and then alter your strategy accordingly.
The U.S. Securities and Exchange Commission has prepared an informative guide to the risks of day trading on its Web site, Day Trading: Your Dollars at Risk.