What is Day Trading?

Published by Thomas Herold in Economics, Trading

'Day Trading' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Day Trading is the stock market strategy of purchasing and selling a given stock all in the say day. This form of trading is completely different from long term investing or even momentum or swing trading, which involves time frames of several days to several weeks. Day traders often try to make money on small movements in the stock price. In these cases they are attempting to leverage bigger amounts of investment capital to capture these lesser price movements in indexes or stocks that are extremely liquid.

Day trading can provide profits that allow individuals to make a living at it. It also can be an easy way for traders to lose money if they do not stick to a carefully designed strategy or if they have no experience in it. There are a variety of strategies that these day traders follow. These include selection, entry, and exit policies.

Entry strategies are critical for day traders. These traders first have to find a stock which works well for the day trading concept. Stocks with both liquidity and volatility are the best candidates. When a stock has liquidity, it is easy to get in and get out of the stock with small spreads and little slippage. Spreads represent the distance between a stock’s bid and ask price. Slippage is the variance between a stock’s actual trading price and the anticipated trading price.

Volatility proves to be the best way to measure the range of the daily price movements. It is in this daily volatility range that day traders work. For day traders, greater volatility can mean the chance to make higher profits or lose more money.

After day traders pick out the right kind of stock, they have to learn the best ways to find good entry points into the stock. Three tools that they utilize in this task are Level II quotes, daily candlestick charts, and actual time news services. Level II quotes show the orders as they occur. Daily candlestick charts give traders price action analysis. Actual time news service is critical since these companies release it directly as the news happens. This kind of news makes stocks move.

Daily and intraday candlestick charts provide a variety of useful information to day traders. They are able to see the volume of the stock and whether it is decreasing or increasing in picture form. The candlesticks can also form patterns like dojis and engulfing patterns that provide insight to these traders. Candlestick patterns may also provide useful elements of technical analysis such as triangle shapes and trend lines of a stock.

The entry strategies that day traders utilize are based on the identical tools that longer term traders employ. A key difference surrounds the proper time to exit the trade. Day traders are looking for the point where the interest in the stock in question decreases. They see this using their Level II volume tools.

Exit strategies are the other main component of a day trading policy. Traders using leverage trade on margin. Margin is borrowed money from the stock broker that multiplies potential gains and losses. Using margin means that a trader has a greater vulnerability to dramatic price movements in the stock than would a longer term trader not using margin. This is why day traders must use stop losses. These exit orders allow traders to sell out of a stock position and limit the losses.

The two different types of stop losses that day traders employ are physical and mental. Physical stop losses are more precise and disciplined. Traders program them to sell the stock at a particular price level that fits the loss the trader is prepared to take.

Mental stop losses are those points where the trader feels his or her reasons for entering have been invalidated. The trader would simply give a sell order at market price to close out of the position immediately. The problem with mental stop losses is that it is too easy for emotions to get involved and for the trader to continue to hold on to the position hoping that it will turn around. This can magnify losses when traders fall into this trap. Day traders should never risk more in a single than they can afford to lose both mentally and financially.

Free Download (No Signup Required) - The 100 Most Important Financial Terms You Should Know!
This practical financial dictionary helps you understand and comprehend the 100 most important financial terms.

The term 'Day Trading' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.