There can be a lot of different terms used to describe trading strategies, personalities and techniques – terms like swing traders, momentum traders, trend traders and day traders. In each case, the object is the same: to make money by profiting from movements in asset prices. The difference between them is the technique employed to try and make that money, and the trading time-frame.
What is a day trader?
A ‘day trader’ is someone who buys and sells financial instruments within the same day, or even multiple times within a day, to take advantage of small market movements.
Intra-day trading is not for the part timer – it takes time, focus, dedication and a specific mindset. It’s the polar opposite of investing, where you seek to benefit from price movements over many years. Day trading involves making fast decisions, and executing a large number of trades for a relatively small profit each time.
Choosing a market to day trade
Day trading is often associated with markets that have fixed closes, although in reality a day trader could trade any asset. Ultimately choosing the market you want to trade on comes down to what you want to trade, what you can afford and how much time you want to spend trading.
The stock market is a popular choice for day traders as there is such a large variety of shares to trade. In the equity market, it is common practice to close out positions at the end of the day to avoid what is known as ‘gapping risk’ – when overnight news and influences could cause a stock price to open significantly higher or lower than the previous day’s close.
But you can be a day trader and still trade markets that are open for 24 hours (or almost 24 hours), such as forex markets and futures markets – including commodities, such as crude oil and indices such as the S&P 500.
Deciding when to day trade
Day traders don’t need to trade all day, but consistency is key. One way to do this is to trade during the same hours every day, usually at a time when there’s traditionally greater liquidity and volatility in the markets.
For the stock market and futures markets, the optimal hours tend to be earlier in the day or just before close. As market hours can vary, it is important to research the opening and closing times of your chosen market before you start to trade.
Day trading forex is slightly different as forex markets are open 24 hours a day. To keep things simple, many traders choose to focus on the hours of a specific exchange or currency pair. For example, EUR/USD typically sees the most volatility between 6am and 5pm (London time), when both London and US traders are active.
It is also important to keep an eye on information releases, as events and earnings announcements can cause price fluctuations throughout the day.
Manage your day trading risk
Many successful traders will manage their trading accounts as though they were running a business – protecting the capital in their account above all else.
Risk management is a crucial step in preparing to trade, by setting your limits and putting measures in place to prevent your worst case scenario. Risk management tools such as stops and limits are an essential part of the any trader’s tool box.
Consider your win-loss and risk-to-reward ratio
You’ll often hear it said that a successful trader cuts losing trades quickly but allows profitable trades to run, and that’s as important in day trading as in any other strategy. By doing this, a trader could have fewer winning trades than losing trades and still grow the capital in the trading account. A trader doesn’t always need to be right, but needs to quickly acknowledge when they’re wrong and take action – ensuring that they’re making more money on winning trades than they’re losing on the ones that go wrong.
There is always conjecture on whether a trader should target a high win/loss ratio or look more closely at the risk-to-reward ratio. Successful day traders will often have low win rates, even below 40%, but will look to target a risk-to-reward ratio of at least 1:2 (meaning the trader expects to double the money that he or she is willing to risk in making that trade). That is a consideration for the individual, but one thing is true: there is nothing wrong with making a mistake and taking a small loss, but staying wrong and realising a big loss is the best way to end a journey as a short-term trader.
Choose a day trading strategy
While it’s often described as one, day trading isn’t really a trading strategy as it only stipulates that you don’t keep a trade open overnight.
Read our article to discover some of the most popular day trading strategies – including swing trading, trend trading and money flows.