Day trading is one of the most misunderstood activities in modern business. It’s been described as everything from gambling to a cause of market crashes. Stories circulate of people who have made millions day trading, while even more are told of those who lost their shirts and even their homes. What’s the truth about day trading? Before we can learn that we have to learn what day trading actually is.
Day trading is simply the buying and selling of financial instruments in the span of the same market day. Day traders seek profits from the short term movements of stocks, futures, options, bonds and other instruments. The life of a day trade can be a few hours to only a few seconds, but usually their life span is between five minutes and one hour.
Typically day traders focus on technical analysis rather that fundamental analysis. Fundamental analysis being the study of, say, a stock from a financial standpoint—that is, its underlying company’s profits, losses, assets and outlook for business. Technical analysis is the study of a stock’s price movements, so traders who employ it generally read prices charts.
Charts come in all timeframes, from monthly charts for long-term traders, to minute charts for the shortest-term traders. Day traders usually focus on one-minute to ten-minute charts. When a chart shows a promising pattern or so-called “set up” for a trade, the trader will enter an electronic order to buy or sell short the instrument. The more cautious traders will at that time enter standing stop loss orders, to exit the trade at a predetermined loss amount if it moves against them. Some will also enter one or more profit targets, to exit all or part of the trade at predetermined profit points. A day trader may enter a few or many of these trades per day. The shortest-term traders, called scalpers, may enter hundreds of trades a day.
Day traders typically work from a computer and send orders via the Internet. Because of the fast-paced nature of day trading, sophisticated programs, call trading platforms, have been developed to facilitate the smooth execution of trades. Trading platforms can display many price charts at once as well as other market data. Most platforms allow for hot key shortcuts to enable the fast execution of favorite trades.
At times day trading at its fastest pace can resemble playing a video game. As such day trading requires a whole other set of skills beyond just being able to recognize good trading opportunities. A day trader must possess steady nerves and quick decision-making skills. The psychological skills required to day trade are not unlike those of driving race cars. The trader, like the driver, must be able to maintain his cool and stick with his training when things are moving extremely fast or even crashing around him. Generally day traders must be knowledgeable, disciplined and fearless. Most mistakes made in day trading are emotional mistakes. Not getting into good trades and not getting out of bad trades are at the top of this list of mistakes. This is true for all types of trading, but in day trading, where the pace is so fast, mistakes can morph into disasters if not handled quickly.
So returning to our original questions, is day trading gambling or destructive? Day trading certainly can be and is gambling to some so-called traders. These players generally don’t last long though. As to being a quick way to riches, only the luckiest of traders gain a windfall as beginners, and most of those will find a way to lose it back in short order.
Day trading is in truth a rarefied but wholly legitimate profession. It is even a needed activity that provides liquidity to today’s markets. When you sell a stock you’ve been holding for years and it sells almost instantly, it was probably purchased from you by a day trader. Day trading is really one of the most democratic and individualistic professions in existence. Day traders compete on a level-playing field and rely on nothing but their skills to succeed. So in a way, day trading is the most American of professions.
Day trading is like other competitive profession that requires rare skills and where only the best of the best really shine and become wealthy. However, while not everyone can access a race car and enter a dangerous road race, anyone can deposit money in a brokerage account, turn on their computer and instantly be transported into the giddy world of day trading, where all that money is at risk. Herein lies the danger of day trading and, as such, it should not be entered into lightly.