Day trading is a type of speculative investing that involves traders buying and selling the same stock or another asset within the same day in an attempt to profit from rapid price changes.
Day trading relies on the intraday volatility of financial markets. On any given day, the stock prices of most liquid stocks Fluctuate from the previous day’s closing prices, and day traders attempt to predict and profit from the timing and direction of those daily price fluctuations.
Day traders typically try to make small, consistent profits on the majority of their trades and compound those profits into large returns over the long term.
Some day traders identify specific market catalysts that tend to generate highly volatile price reactions. These catalysts are typically special events such as earnings reportscompany news announcements, or even buyout deals and partnerships.
Because the underlying fundamental value metrics For most stocks rarely change within a matter of minutes or hours, day traders often use technical analysis to determine potential entry and exit points for a trade. Technical analysis relies on identifying patterns in market data to predict future price movement based on market tendencies.
Day traders typically focus on highly liquid stocks because those stocks allow traders to enter and exit positions quickly. Liquid stocks typically also have relatively small bid-ask spreads, the gaps between the price of a trader pays to buy a stock and the slightly lower price a trader receives when selling a stock. Large bid-ask spreads can eat into day-trading profits.
Day traders may take both long and short positions throughout the day, attempting to profit from both rising and falling stock prices. They may trade many different stocks and other securities throughout the day, or they may buy and sell the same stock several different times in a matter of hours depending on their trading strategy.
Momentum day traders attempt to recognize a stock that is moving in one direction and get in and out of a position before the stock loses its momentum. Momentum traders can use stop-loss orders to automatically close out a position if the stock changes direction.
Scalping is a type of day-trading strategy that involves making a large number of trades that are each minimally profitable. Instead of trying to capture a single 1% or 2% move in a stock, a scalp trader may attempt to capture 10 or 20 different moves of 0.1% in a single day.
Breakout trading involves identifying a stock that is trading in a particular trend or pattern and then entering a trade when it appears to break out of that trend or pattern. Breakout day traders often use trend lines, moving averages or other indicators to identify potential breakouts.
Day trading is just one of several popular investing styles. By definition, day traders enter and exit positions within a single day, closing out all positions before the market closes. Swing traders typically also enter and exit stocks with a relatively short-term mindset, but they may maintain an open position for days or weeks before closing it.
Traders who recognize a longer-term trend in stocks are called trend traders. Trend traders may maintain a position for months or even longer until the trend breaks. Finally, buy-and-hold investors identify stocks and other investments that they believe will generate positive returns for years. Value investors such as Berkshire Hathaway Inc. (BRK.A, BRK.B) CEO Warren Buffett are considered buy-and-hold investors because they may maintain stakes in companies for years or even decades.
The Financial Industry Regulatory Authority defines a pattern day trader as any trader who executes four or more day trades within five business days. The number of day trades must also be more than 6% of the trader’s total trades in the account during that period. Traders classified as pattern day traders are subject to specific rules enacted to protect traders from the risks associated with day trading.
Pattern day traders must maintain a minimum of $25,000 in equity in their margin account on any day they day trade. Day traders are also restricted from trading in excess of their buying power, which is typically up to four times the maintenance margin excess as of the end of the previous day.
Day trading is generally considered one of the most exciting ways to make a living investing in the stock market, but it is also extremely risky. Historically, day trading has become extremely popular during periods of stock market booms and bubbles, such as the bull market that began in March 2020.
A 2020 study of day traders in the Brazilian equity futures market found that less than 3% of day traders generated an overall profit over one year and only 0.5% of day traders earned more than the starting salary of a bank teller. Day traders are competing against professional institutional traders that have virtually unlimited resources, insider experience and high-frequency trading algorithms that can enter and exit positions in fractions of a second.
For the minority of day traders who identify trading systems that work consistently over time, the theoretical upside to their profits is only limited by how many trades they can make. Day trading is exciting and rewarding when it works, and it allows traders to work from home and be their own bosses. Day trading can provide instant gratification, potentially paying off in a matter of seconds. Long-term investments can take years to pay off. Day traders who close out all their positions before the end of the day also aren’t exposed to multiday trading risks, including market-moving news that breaks when the stock market is closed.
Day trading is extremely difficult, and day traders are statistically unlikely to generate consistent profits. Day traders must be committed to meticulously tracking and monitoring the market any time they are trading. Even a five-minute delay in reacting to a critical piece of breaking news could turn an otherwise benign day trade into a large losing position. Many day traders rely on margin and leverage to increase their potential gains, both of which also ramp up risk and potential losses. Finally, profits on day trades are taxed as short-term capital gains, which have higher tax rates than long-term capital gains.
A limited amount of day trading has taken place in US markets since the first ticker tape was developed in 1867. At that time, day traders could not place orders directly on the New York Stock Exchange floor and instead were forced to call stockbrokers to place orders on their behalf. Online day trading in its modern form first became popular during the dot-com bubble in the late 1990s with the launch of online brokerages. These brokers made it easy for any person with a computer and an internet connection to trade stocks from the comfort of home.
Pattern day traders must maintain a minimum of $25,000 in equity in their margin account on any day they day trade.
A trading edge is an advantage or insight into the market price action that allows a day trader to identify trading opportunities that consistently produce good long-term outcomes.
If a day trader exceeds the buying power of a particular account, their brokerage will issue a day-trading margin call and the trader will have no more than five business days to deposit additional funds in the account to satisfy the call.