Day trading 101: What it is and how it works

Day trading is a high risk strategy that involves speculating on the price of financial instruments.Some tout it as a way to make fast money, while others think it is closer to gambling at the casino.

Is day trading worth it? It depends on your risk tolerance and skill level.

What is day trading?

Day trading is the act of buying and selling the same security over the course of a single trading day. Often traders only hold onto their positions for a number of minutes op even seconds.

It has very little to do with investing in a traditional sense as you are not looking to hold assets over the long-term. Instead, traders are looking to exploit price movements within assets.

Day trades can be executed in any market but occur most often in the stock and forex markets. Day traders typically aim to end the day with no open positions, which means they don’t hold securities overnight.

When it comes to day trading, speed is vital as it is all about making money on small price movements.

How does it work?

Day traders apply a significantly different approach to trading than buy-and-hold investors.

Unlike passive strategies that seek long-term stability when selecting securities, day traders apply an active trading strategy that capitalises on market volatility.

Day traders use short-term market fluctuations and high leverage to their advantage, pouncing on small price movements to turn a profit.

To make money on such small price movements, day traders must be willing to invest sizeable sums. This is because you are trading on price interest points or pips which is a fraction of a share. That, or trade options contracts, as the costs are often lower — though risks remain high. The more you invest, the more you have to gain — and more you stand to lose.

Why is it so controversial?

You might've heard that day trading has a bad wrap.

This is because newer investors especially often make large losses quickly. Although this can happen to even the most experienced traders.

As such, many professional money mangers, financial advisors and retail investors will shy away from day trading. These investors will argue that day trading is simply not worth the risks. Instead they will focus on accumulating assets over the long-term.

Risks and rewards

Day trading is a high-risk, high-reward investment strategy.

Often investors will lose more money than what they begin with. Stats released by The Australian Securities and Investment Commission (ASIC) shows in 2021, 72% of retail investor who traded CFDs lost money. While not all day trading is CFDs, the odds of success are certainly against traders.

How to lower your risk while day trading

It goes without saying that day trading is a risky proposition.

But there are a few things you can do to offset some of the risks:

• Trading courses. The more you know about the market, the better. Invest in some trading courses, stock market games and investment books to grow your knowledge and confidence.
• Stop-loss orders. Stop-loss orders help pump the brakes on potential losses by letting you set the lowest price you’re willing to sell a security.
• Demo trading. Put your trading strategies to the test with a demo trading account, an account designed to simulate market trades using hypothetical money.
• Use reliable hardware. Remember day trading is about speed. So if you have a slow internet connection it can cost you. It is worth making sure you have technology that matches your trading.

Outside these practices, day traders can also reduce risk by using the 1% rule — a twist on the popular core and explore strategy.

Christopher Liew, Chartered Financial Analyst (CFA), tells Finder: “Day traders can employ a common risk-management strategy called the 1% rule wherein traders don’t invest beyond 1% of their entire trading account in a single trade to manage possible losses.”

The 1% rule isn’t unlike the core and explore strategy — a strategy that allocates a majority of portfolio funds to low-cost diversified funds and leaves the rest for high-risk trades like growth stocks or day trades. Core and explore might reserve 10% for riskier trades instead of 1% — but your number depends on the amount of risk you can afford to take.

Michael Shea, certified financial planner (CFP) and IRS enrolled agent, offers a similar approach: “If you want to day trade, set aside an amount of money you’re 100% okay with losing. Make sure your retirement portfolio and savings are taken care of first, and if you have money left over to gamble on day trading, then have at it.”

Investing strategies

There are several short-term strategies you can explore.

But here are a few of the more popular trading strategies:

Trend trading: This involves studying the past price movements of stocks within a specific time frame, usually several months. From this evidence, trend traders make predictions about the direction stock prices will make in the future. They aim to buy stocks early during an upward trend and sell when they believe they will reach their peak based on the available evidence.

Swing trading: This strategy entails holding onto a stock for a period of between a few days to a few weeks. Swing traders use different analytical methods and tools to predict the highs and lows of a stock's price movements and then sell on the upside if those predictions materialise.

News-based trading: This strategy relies on — you guessed it - news. News events can have a powerful impact on affected industries and sectors. News-based trading aims to wield the volatility triggered by news events to the trader’s advantage.

To execute these strategies, you'll need a brokerage account.

Trading on margin

Margin trading is trading with borrowed money. When you trade on margin, you borrow funds from your broker to execute a trade. You’ll be asked to pay back what you owe with interest and your account serves as collateral for the loan.

So long as the trade moves in your favour, trading on margin can be a lucrative practice: You increase your buying power by borrowing funds, execute a profitable trade, pay back what you owe and pocket the profit.

The problem with margin trading is that the potential to compound the results of a trade swings both ways: you may increase your profit — but you may also multiply your losses. Stop-loss orders may help cushion the impact, but margin trading remains an inherently risky strategy best reserved for those with extensive trading experience.

What to look for in a day trading broker

The right broker can make or break your day trading experience. Here’s what to look for in a broker:

• Reliability. The last thing you want to worry about when executing a sizable trade is a service outage. Unfortunately, outages do happen, and some brokers are more prone to them than others.
• Speed. Day trading is a time-sensitive activity, so your broker’s fill times will factor into successful trade execution. Look for slow fill time complaints on trading message boards to find out which brokers have a reputation for delayed executions.
• Reputation. Your ideal day trading broker should maintain a positive online reputation. Review trader feedback on the Better Business Bureau, Trustpilot and Reddit to find out what investors think of the platform.
• Research tools. Many day traders rely on up-to-date market news and research tools — like advanced stock screeners and charts — to pull off profitable day trades. Find out what research and analytics tools your broker offers and whether they’re sufficient to support your trading strategy.

Analytical tools

Sophisticated analytical software can help inform day trading decisions and may include any of the following:

• Automated pattern recognition. This software is capable of detecting technical patterns like flags, channels and Elliot Wave patterns.
• Neural network applications. These programs utilise neural networks to detect predictable patterns in price movement.We add
• Backtesting. This program lets traders backtest trading strategies to analyse how they would have performed in the past.

Bottom line

Day trading isn’t for everyone. It’s potentially profitable, but even with a solid strategy, a reliable broker and the right tech, the risk of losing money is high. Day traders must be prepared to lose capital, especially when trading on a margin.

The right broker can play a pivotal role in your success as an investor.

Compare stock trading platforms

To day trade, you'll need a brokerage account. Compare your options by platform features, fees and research tools to find the broker best suited to your investment goals.

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Name	Product	Monthly fee	Options trading fee	Standard brokerage fee
CMC Invest Finder Award		$0	$33	$0	$0 brokerage on US, UK, Canadian and Japanese markets (FX spreads apply). Trade over 45,000 shares and ETFs from Australia and 15 major global markets. Plus, buy Aussie shares or ETFs for $0 brokerage up to $1,000 (First buy order of each security, each day - excludes margin loan settled trades).	Go to siteMore Info Compare	loading Fetching your data...
Tiger Brokers Finder Award		$0	US$0.95/contract (Min. US$3 per order)	US$1.99	Trade US, Asian and CHESS-sponsored ASX stocks and US options.	Go to siteMore Info Compare	loading Fetching your data...
Webull Exclusive		$0	US$0.50	US$0.25	Finder exclusive: Get an additional 20 $0 brokerage trades. Get up to $500 in trading vouchers when you deposit funds. T&Cs apply. Trade over 3,300 Australian and US ETFs with $0 brokerage.	Go to siteMore Info Compare	loading Fetching your data...
Moomoo Share Trading Exclusive		$0	US$0.50	US$0.99	Finder exclusive: Unlock up to AUD$4,000 AND US$4,000 in $0 brokerage over 60 days. T&Cs apply. Trade US, Asian and CHESS-sponsored ASX stocks and get access to social trading.	Go to siteMore Info Compare	loading Fetching your data...

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Important: The standard brokerage fee displayed is the trade cost for new customers to purchase $1,000 of either Australian or US shares. Where a platform charges different fees for both US and Australian shares we show the lower of the two. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.

Written by

Shannon Terrell

Writer

Shannon Terrell is a writer for Finder who studied communications and English literature at the University of Toronto. On any given day, you can find her researching everything from equine financing and business loans to student debt refinancing and how to start a trust. She loves hot coffee, the smell of fresh books and discovering new ways to save her pennies. See full bio