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If you’re new to trading you’re likely to start coming across a number of terms that attempt to describe trading 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 moves in asset prices. The difference between them is the technique employed to try and make that money and the trading time-frame.
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 taking fast decisions, and you make money by executing a large number of trades for a relatively small profit each time.
The term ‘day trader’ is often associated with markets that have fixed closes, such as the equity market, although in reality a day trader could trade any asset. In the equity market, the trader will exit all positions before the market closes to avoid what is known as ‘gapping risk.’ This is where an individual stock price could open significantly higher or lower (a gap) than the previous day’s close as fresh overnight news and influences are priced into the stock.
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 for instance for crude oil and indices including the S&P 500. Day traders will generally trade a specific period in the session, and most seem to gravitate to the late European/early US day, when there’s traditionally greater liquidity and volatility in the markets.
Day trading and risk management
Take a look at the world’s most famous and successful traders and they all have one thing in common: they develop a trading strategy that they have confidence in. They have the control and discipline to provide them with either a statistical edge or a positive expectancy that they will be the one taking capital from the market. They will manage their trading accounts as though they were running a business and will recognise that they are managers of risk. They will protect the capital in their account above all else. Just as with any types of trading, risk management tools such as stops and limits are an essential part of the trading tool box.
Day traders have to think very differently from investors. Buying low and selling high might not always be in their best interests. There are a large number of strategies that day traders can employ, including mean reversion strategies, following money flows and trading trends. They could also look at swing trading or scalping.
What’s in a trading strategy?
Trend trading: trend traders try to make money by studying the direction of asset prices and buying or selling depending on which direction the trend is taking. If the trend is upwards and prices are making a succession of higher highs, then traders take a long position by buying. If the trend is downwards and prices are making a succession of lower lows then traders take a short position by selling.