What is Day Trading? (Should I Consider It?)

It's amazing how many people in the U.S. are involved in the stock market, whether they know it or not.

Sure, many people actively invest in stocks through their brokerage firm, online brokers, or other investments accounts.

But there are also tens of millions of people who invest in stocks through mutual funds held in their retirement accounts.

These folks aren't always aware of exactly what it is they're invested in but as long as the returns are good, they're all-in.

Aside from investors who hold their stock investment for long periods, there's another type of individual investor called a “day trader.”

The world of day trading is fast and furious because stock investments are bought and sold on the same day for measured profits.

It's not a process for the faint of heart because the risks are high.

As you might imagine, the higher risk usually means potentially higher returns. Yet it can also mean more significant and faster financial losses on trading days.

What is a Day Trader?

Day trading is a form of investing that involves the constant rollover of transactions made intra-day.

As a process, day trading can be done on any kind of investment where the market is easily accessible and the investment instruments being traded are very liquid.

Typically, day traders will focus on investment opportunities that experience a high volume of activity with higher levels of volatility.

Common investment targets for day traders include stocks, stock options, commodity contracts, and currencies (including cryptocurrencies).

The premise behind the day trading concept is to identify investments that will likely move in one direction or the other during a given day, such as stock prices.

By identifying such investment opportunities, day traders can leverage their investment funds to create profits within a short period, usually within the same day.

If a trade is successful, the returns can be pretty attractive if viewed in terms of how long it took the investment funds to create the profit.

The multiple can be massive on a very successful day trade.

But keep in mind that the loss of real money can be equally as vast.

The Profile of a Typical Day Trader

As you contemplate the possibility of becoming a day trader, it might behoove you to understand just exactly what kind of investors typically makes good day traders.

Remember, the risks are higher because of the limited period of time available to recover from investment mistakes or losing positions.

With that in mind, here are some common characteristics of people who tend to do well and make money day trading.

Market Knowledge

Regardless of the trading market (stocks, commodities, etc.), the typical successful day trader will have trading experience and a thorough understanding of the market in which they're trading.

That understanding will include knowledge about the fundamentals affecting the market and the trading dynamics involved with making trades.

They'll also know how to use technical analysis to identify potential trading opportunities.

Financial Resources for Trading

Much like a gambler who gambles, a day trader should never risk more money than they can afford to lose.

Managing financial resources is a vital part of a successful day trading process because losses are as likely as gains

A wise day trading investor of any kind will never invest/risk more than what they would consider their “discretionary” capital.

Discretionary capital = what's remaining after bills are paid, and money has been set aside for savings.

Pattern day traders, those who execute four or more “day trades” within five business days, must have at least $25,000 in their accounts and can only trade in margin accounts, under FINRA rules.

Note: margin trading is an advanced investment strategy that is extremely risky and not appropriate for most investors.

Having a Plan or a Strategy

Good day traders always have a method behind their madness. They will study or develop investment strategies that might give them some kind of edge over other investors.

Common strategies used by day traders include:

• Trading on news information
• Making trades based on specific technical analysis
• Arbitrage trading (leveraging both sides of the same trading opportunity)
• Adopting swing trading formulas
• Trading stocks based on merger/acquisition possibilities

Disciplined

Given what is being put a risk, a good trader needs the discipline to stay the course with their investments.

That means they must have the discipline to accept previously determined returns without pushing for higher returns.

They must also be disciplined to admit a trading mistake and limit their losses. Stop-loss strategies can help limit losses from trades gone bad.

Ultimately, traders must have the discipline to walk away from day trading when enough is enough.

Access to the Tools of the Trade

Day traders need reliable devices from which they can facilitate instant trades.

They also need access to a trading platform that can handle the trades they need to make when they need to make them. That includes immediate execution of trades.

Finally, they need access to information. Information could be news, technical analysis, or recommendations from a trusted prognosticator.

Without these trading tools at their disposal, the exposure to potential problems becomes unacceptably high.

Understanding the Concept of Risk

There isn't much difference between investing and gambling. Both processes involve risking money for a return.

Admittedly, investment markets offer a more controlled environment, but the risks are still present and very real.

A good day trader understands that higher rewards require higher risks.

It's incumbent on each day trader to determine their own level of “risk-tolerance.”

Traders with more discretionary capital will typically be willing to accept more risks for higher potential rewards. It's challenging to accept risk and succeed as a day trader when investing with “scared” or limited funds.

Commitment and the Investment of Time

A true day trader views the day trading process as a full-time job. The trader needs to be free to make their trades and monitor their positions at all times.

Many failed day traders will openly point to their failures and state that their inability to invest time and commit to the process led to their downfall.

Should I Consider Day Trading?

Day trading may be hyped as a great side hustle by some, but you should never underestimate the importance of the decision to try your hand at day trading or not.

“Day trading is not for the faint of heart as it involves minute to minute decision-making, as well as leveraged investment strategies that can lead to substantial losses… Day trading can move very quickly, and you may not have time to research every investment thoroughly. Take your time and don't ever invest in anything you haven't thoroughly and independently researched. Most importantly, if you don't understand the investment, don't buy into it.” – Investor.gov

Quitting your current job or putting your career on hold to try your hand at day trading stocks is not a decision you should rush.

You also need to be realistic about the financial resources you have available to support your day trading activities.

And don't forget about the tax implications of investment gains.

Ultimately, It's simply a matter of being honest about your financial situation, yourself, and your abilities as an investor.

Take a hard look at the characteristics of a good trader.

If you possess these characteristics and understand the risks of day trading, your chance of success as a day trader is substantially higher.

Otherwise, stick with the long game investing strategy to reach your financial goals.

Next: What Does it Take to Be a Successful Investor?