Day trading strategies for beginners
Day trading is one of the most popular trading styles, especially in the US. Here are some of the things that you need to know about day trading and how to get started.
Day trading explained
Day trading involves buying and selling financial instruments within a single trading day – closing out positions at the end of each day and starting afresh the next. Day traders buy and sell multiple assets 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 as it takes time, focus, dedication and a specific mindset. Day trading involves making fast decisions, and executing a large number of trades for a relatively small profit each time. It’s generally thought of as the opposite to most investment strategies, where you seek to benefit from price movements over a longer period of time.
What are the best markets for day trading in the US?
Day trading is often associated with markets that have fixed closes, although in reality you can be a day trader and still trade markets that are open for 24 hours (or almost 24 hours). Ultimately choosing a market to day trade comes down to what you are interested in, what you can afford and how much time you want to spend trading. A popular day trading market is:
The forex market is another popular choice for those starting their day trading journey due to the vast amount of currency pairs to trade and the high market liquidity – the ease at which currencies can be bought and sold. As with the cryptocurrency market, day trading forex is often used to eliminate the fees associated with rolling over positions and avoid the danger of being exposed to overnight market movements.
What you need to know before you start day trading
There are a few key factors to consider before you start to day trade any market, as the practice can require a lot more time than the typical buy and hold strategy. With investing, the focus is on longer term market movements, so daily movements have little impact on the overall picture. However, when you day trade, the focus is on the factors that can affect intraday market behaviour. These include:
- Liquidity. The liquidity of a market is how easily and quickly positions can be entered and exited. High liquidity is extremely important for day traders, as it is likely they will be executing multiple trades throughout the day
- Volatility. The volatility of an asset, or how rapidly the price moves, is an important consideration for day traders. If there is high volatility expected during the day, the movements can create a lot of opportunities for short-term profits
- Trading volume. An asset’s trading volume is a measure of how many times it is being bought or sold in a given period. A high trading volume shows that there is a lot of interest, and is useful for identifying entry and exit points
Top 5 day trading strategies
Day trading isn’t really a trading strategy itself as it only stipulates that you don’t keep a trade open overnight – it’s simply a trading style. Five popular day trading strategies include:
Trend traders attempt to make money by studying the direction of asset prices, and then buying or selling depending on which direction the trend is taking.
If the trend is upwards, with prices making a succession of higher highs, then traders would take a long position and buy the asset. If the trend is downwards, with prices making a succession of lower lows, then traders would take a short position by selling.
Trend trading isn’t exclusively used by day traders because you can keep your position open for as long as the trend continues. However, if you are sticking to intra-day trading, you would close it before the day is over.
Swing trading is all about taking advantage of short-term price patterns, based on the assumption that prices never go in one direction in a trend. Instead, swing traders look to make money from both the up and down movements that occur in a shorter time frame.
While trend traders seek to take advantage of long-term market trends, swing traders tend to be more interested in the small reversals in a market’s price movement. They attempt to spot these reversals ahead of time, and trade to make profits from smaller market moves.
Scalping is a short-term trading strategy that takes small but frequent profits, focusing on achieving a high win rate. The theory is that you can just as easily build a big trading account by taking smaller profits time and time again, as you can by placing fewer trades and letting profits run. Scalping requires a very strict exit strategy as losses can very quickly counteract the profits.
Most scalpers will close positions before the end of the day, because the smaller profit margins from each trade will quickly get eroded by overnight funding charges.
Mean reversion is based on the theory that prices, and indeed other measures of value such as price-to-earnings (P/E) ratios, always eventually move back towards the historical mean.
The strategy uses technical analysis, such as moving averages, to catch assets whose recent performance has differed considerably from their historical average. Mean reversion traders will then take advantage of the return back to their normal trajectory.
The money flow indicator signals whether an asset might be oversold or overbought – using volume and price rather than the asset’s price alone.
It works by comparing the number of trades from the previous day to the current day, to determine whether the money flow was positive or negative. A reading of 80 or higher indicates overbought conditions and is a signal for the trader to sell. Whereas a reading of 20 or below indicates oversold market conditions and is a signal to buy.
Choose how to day trade
The first step on your journey to becoming a day trader is to decide which product you want to trade with. Derivatives are popular for day trading, as there is no need to own the underlying asset you are trading. This means that you can open and close positions much faster and speculate on the price of a market whether it is rising or falling in price.
Create a day trading plan
Before you start to day trade, it is important to outline exactly what you are hoping to achieve and be realistic about the targets that you are setting yourself. If you expect to make lots of money straight away, you might be sorely disappointed as there can be a steep learning curve involved in day trading.
It is also important to consider exactly how you are going to create a methodology for entering and exiting the market, and whether this will be based on fundamental or technical analysis. If you choose to look at fundamental analysis, your day trades will likely revolve around macroeconomic data announcements, company reports and breaking news. Whereas if you decide to use technical analysis, you would likely focus on chart patterns, historical data and technical indicators.
Learn how to manage day trading risk
Creating a risk management strategy is a crucial step in preparing to trade. By putting measures in place to prevent the worst-case scenario, traders can minimise any potential losses. Risk management tools such as stops and limits are an essential part of the any trader’s toolbox.
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. 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. 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 perhaps the quickest way to end a journey as a short-term trader.
Open and monitor your first position
Once you are confident with your trading plan, it is time to open your first position. Within a single trading day, it is likely that you’ll want to place both long and short positions. If you think that a market is going to rise, you would opt to ‘buy’ the asset, whereas if you think that a market is due to decline, you would choose to ‘sell’ it.
Remember, when you’re a day trader you’ll likely be opening and closing multiple trades within the same day, so it is important to keep up to date with any market events or breaking news that could impact the prices of the markets that you are focusing on. You can do so by using our news and trade ideas.
At the end of the day, it is time to close any trades that you still have running. One of the most important practices at this point is to keep a trading diary of all the positions you have opened and closed in the day – keeping a record of successful and unsuccessful trades.
Day trading summed up
To help you get started day trading, we’ve compiled a list of the key things you need to know:
- Day trading is the practice of opening and closing positions within the same trading day
- Traders choose to use this style to prevent the risk of slippage or to avoid overnight funding costs
- Day trading requires a lot of time and dedication, so it is not commonly used by part-time traders
- It is important to consider the liquidity, volatility and trading volume of a market before you start to day trade
- There are multiple day trading strategies that you can use, including trend trading, scalping, swing trading, mean revision and money flows
- Before you start trading, there are a few crucial steps to take such as establishing how you will trade, your trading plan, your risk management strategy and opening your first position
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