What is day trading? Day trading is a term that refers to very short term investing. The investor may hold a position for only minutes, or in extreme cases seconds, but in any case all trades are settled before the market closes for the day. While day trading can be risky, closing all trades removes the risk of markets opening in a different position while traders cannot exit a position.
The main principle of day trading is to predict the way the market is likely to move and take a position in order to profit from the movement. Day traders can profit from either a rising or falling price by taking advantage of derivatives. These include instruments that allow traders to sell stock they don’t own in the hope they can buy it cheaper later, or to agree a price for a future purchase which they hope will give them a discount for the stock at that point. These strategies can be high risk as if a price moves in the opposite way the trader still has the liability to complete the trade which can give them a large loss.
Stocks are not the only market for day traders; foreign exchange and commodities are also commonly used. Most day traders will have a specialized area of interest and will tend to wait for the opportunity in their market rather than trying to cover everything.
Because the potential for share price movements in a short time frame are lower most day traders will use very large volumes of stock in order to make the returns they want. This does increase the potential for losses as well as the potential for gains. Some will also use borrowed money to make the investment, which is known as trading on margin, but this will still need to be repaid if they make a loss. A day trader will not necessarily need to hold the full price of the stock to make the trade but they will always need to be able to cover any losses if the market moves against them.
There are a wide range of techniques used by day traders to identify the opportunities for trades. The largest driver of share price fluctuations during the day is the news and day traders will have a close eye on any reports coming out. Beyond this the individual strategies used place different importance on a wide range of factors and information available. Some large traders will even use computer systems that spot the opportunities and make the trades based on predefined parameters.
Day trading can provide big returns for experienced investors and in a much shorter timescale than with value investing. The technique does mean that the trader has to be watching the market full time as long as they have positions open and will require good access to information and a broker that can fulfil orders quickly when required. It is always worth remembering that when the potential for returns increase the potential for losses tends to increase as well.