by Justin Kuepper
Day trading is defined as the buying and selling of a security within a single trading day. This can occur in any marketplace but is most common in the foreign-exchange (forex) market and stock market. Typically, day traders are well educated and well funded. They utilize high amounts of leverage and short-term trading strategies to capitalize on small price movements in highly liquid stocks or currencies. Day traders serve two critical functions in the marketplace - they keep the markets running efficiently via arbitrage and they provide much of the markets' liquidity (especially in the stock market). This article will take an objective look at day trading, who does it and how it is done.
The Controversy
Search "day trading" on Google and you will see why there is controversy! The profit potential of day trading is perhaps one of the most debated (and misunderstood) topics on Wall Street. Countless internet scams have capitalized on this confusion by promising enormous returns in a short period. Meanwhile, the media continues to promote this type of trading as a get-rich-quick scheme that always works. The truth lies somewhere in the middle. There are those who engage in this type of trading without sufficient knowledge (or some even admittedly for a gambler's high!); however, there are day traders who are able to make a successful living.
Many professional money managers and financial advisors shy away from day trading, arguing that in most cases the reward does not justify the risk. They often cite that no day trader is world renown, whereas icons like Warren Buffett and Peter Lynch are a testament to the success that can be attained by more traditional forms of investing. Conversely, those who do day trade insist there is profit to be made. They say the success rate is inherently lower as a result of the higher complexity and necessary risk of day trading, combined with all the related scams.
Overall, the street remains divided on the issue. At the very least they agree that day trading is not for everyone and involves significant risks. Moreover, it demands an in-depth understanding of how the markets work and various strategies for profiting in the short term. Now we'll take a look at the various aspects of day trading.
Characteristics of a Day Trader
This article will focus on professional day traders - that is, those that trade for a living, not simply as a hobby or for a “gambling high”. These traders are typically well-established in the field and have in-depth knowledge of the marketplace. Here are some of the prerequisites to day trading:
- Knowledge and Experience in the Marketplace
Individuals who attempt to day trade without an understanding of market fundamentals often end up losing money. - Sufficient Capital
One cannot expect to make money day trading. Day traders use only risk capital, which they can afford to lose. Not only does this protect them from financial ruin, but it also helps eliminate emotion from their trading. A large amount of capital is often necessary to capitalize effectively on intra-day price movements. - A Strategy
A trader needs an edge over the rest of the market. There are several different strategies that day traders utilize, including: swing trading, arbitrage as well as trading news, among others. These strategies are refined until they produce consistent profits and effectively limit losses.
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- Discipline
A profitable strategy is useless without discipline. Many day traders end up losing a lot of money because they fail to make trades that meet their own criteria. As they say, “Plan the trade and trade the plan.” Success is impossible without discipline.
