Day Trader

What is a Day Trader?

A day trader is a trader who executes a large volume of short and long trades to capitalize on intraday market price action. The price action is a result of temporary supply and demand inefficiencies caused due to purchases and sales of the asset.

Key Takeaways

• Day traders are traders who execute intraday strategies to profit off price changes for a given asset.
• Day traders employ a wide variety of techniques in order to capitalize on market inefficiencies.
• Day trading can be a lucrative undertaking, but it also comes with a high degree of risk and uncertainty.

Basics of a Day Trader

There is no special qualification required to become a day trader. Instead day traders are classified based on the frequency of their trading. FINRA and NYSE classify day traders based on whether they trade four or more times during a five-day span, provided the number of day trades is more than 6% of the customer's total trading activity during that period or the brokerage/investment firm where they have opened an account considers them a day trader. Day traders are subject to capital and margin maintenance requirements.

A day trader often closes all trades before the end of the trading day, so not to hold open positions overnight. A day traders' effectiveness may be limited by the bid-ask spread, trading commissions, as well as expenses for real-time news feeds and analytics software. Successful day trading requires extensive knowledge and experience. Day traders employ a variety of methods to make trading decisions. Some traders employ computer trading models that use technical analysis to calculate favorable probabilities, while some trade on their instinct.

A day trader is primarily concerned with price action characteristics of a stock. This is unlike investors who use fundamental data to analyze the long-term growth potential of a company to decide whether to buy, sell or hold its stock.

Price volatility and average day range are critical to a day trader. A security must have sufficient price movement for a day trader to achieve a profit. Volume and liquidity are also crucial because entering and exiting trades quickly is vital to capturing small profits per trade. Securities with a small daily range or light daily volume would not be of interest to a day trader.

Day Trader Techniques

Day traders are attuned to events that cause short-term market moves. Trading the news is a popular technique. Scheduled announcements such as economic statistics, corporate earnings or interest rates are subject to market expectations and market psychology. Markets react when those expectations are not met or are exceeded, usually with sudden, significant moves, which can benefit day traders.

Another trading method is known as fading the gap at the open. When the opening price shows a gap from the previous day’s close, taking a position in the opposite direction of the gap is known as fading the gap. For days when there is no news or there are no gaps, early in the morning, day traders will take a view on the general direction of the market. If they expect the market to move up, they would buy securities that exhibit strength when their prices dip.

If the market is trending down, they would short securities that exhibit weakness when their prices bounce. Most independent day traders have short days, working two to five hours per day. Often they will practice making simulated trades for several months before beginning to make live trades. They track their successes and failures versus the market, aiming to learn by experience.

Advantages and Disadvantages of Day Trading

The most significant benefit of day trading is that positions are not affected by the possibility of negative overnight news that has the potential to impact the price of securities materially. Such news includes vital economic and earnings reports, as well as broker upgrades and downgrades that occur either before the market opens or after the market closes.

Trading on an intraday basis offers several other key advantages. One advantage is the ability to use tight stop-loss orders—the act of raising a stop price to minimize losses from a long position. Another includes the increased access to margin—and hence, greater leverage. Day trading also provides traders with more learning opportunities. 

However, with every silver lining, there are also storm clouds. While day trading can be highly profitable, it still comes with plenty of risks. Disadvantages of day trading include insufficient time for a position to see increases in profit, in some cases any profit at all, and increased commission costs due to trading more frequently which eats away at the profit margins a trader can expect.

Pros

• Positions are usually closed at the end of each day, and are so unaffected by risk from overnight news or off-hours broker moves.
• Tight stop-loss orders can protect positions from extreme movements.
• Regular traders have access to increased leverage and lower commissions.
• Numerous trades increase hands-on learning experience.

Cons

• Frequent trades do mean multiple commission costs.
• Some assets are off-limits, like mutual funds.
• There may not be sufficient time for a position to realize a profit before it has to be closed out.
• Losses can mount quickly, especially if margin is used to finance purchases. Margin calls are a real risk.