What is Day Trading? The Basics & How to Get Started

Day trading is a short-term style of trading that aims to capitalize on intraday price movements. By definition, a day trader may make many trades within a day, but will close their positions before it ends. The goal is to lock in quick profits from price fluctuations during the day. In doing this, day traders avoid the risk of holding market positions overnight and they also don’t have to pay any interest on the margin they use. Margin balances accrue interest after settlement, so day traders typically don’t pay margin interest fees.

Other trading-related terms you may have heard mentioned are scalping, swing trading and long-term investing. Scalping refers to hyper short-term trading, where trades are usually entered and exited within seconds or minutes. Swing trading describes a trading style where market positions are held for days, weeks or months. Positions held for over a year are usually described as long-term investing.

There are several important requirements to become a day trader. Here are some of the key points to keep in mind:

• Make sure that you are adequately capitalized. To actively day trade stocks in the US, it is required that you maintain a balance of $25,000 in your trading account. In the UK this doesn’t apply, as long as you trade with an FCA-regulated broker.
• Get the appropriate hardware. A computer with high-speed RAM (Random Access Memory) and a fast processor (CPU) is optimal. Additional monitors for charts and other data may be helpful.
• Make sure you have a reliable, high-speed internet connection. Speed is the name of the game when it comes to day trading.
• Select a good broker. Look for a reputable, FCA-regulated broker that provides fast, reliable execution, low fees and good customer service.
• Direct Market Access (DMA). If you are planning to day trade stocks, consider working with a broker that provides Direct Market Access, which enables faster order execution.
• Educate yourself. Day Trading for Dummies by Ann C. Logue is a good reference for beginners and Trading in the Zone by Mark Douglas is a classic book on trading psychology. Technical Analysis of the Financial Markets by John Murphy is considered by many to be the most authoritative text on the subject.
• Choose a strategy. Find a trading strategy that suits you and test it using a demo account. Most brokers offer free demo accounts that allow you to practice trading in live market conditions without risking any real money. Software platforms such as TradeStation and MetaTrader allow traders to backtest their strategies using historical data, showing them how they would have performed during a given period.

Here are some of the most popular types of trading strategies that are used in day trading:

• Trend trading strategies. These aim to profit from an asset continuing to move in the direction of a prevailing trend. An example of a trend trading strategy is a breakout strategy, where a trader looks for price to ‘break out’ above or below a key technical level and continue in the direction of the broader trend.
• Mean reversion strategies. This type of strategy aims to capitalize on the idea that after an extreme price move, prices tend to revert back to average levels. Bollinger Bands® are an example of an indicator that is used as part of a mean reversion trading strategy.
• News trading strategies. An example of a news trading strategy is looking at how economic data came out in relation to analyst expectations and making a trading decision based on that. For example, if UK employment data beats analyst expectations, a day trader might decide to buy FTSE 100 futures or the iShares Core FTSE 100 UCITS ETF (ISF). 
• Price action strategies. This method of trading uses pure price movement on a chart with minimal or no use of indicators. Patterns such as ‘pin bars’ and ‘inside bars’ give clues on whether price will continue in the direction of the trend or potentially reverse.
• Gap trading strategies. Gaps are spaces on a chart where the price of a financial instrument jumps higher or falls lower, with little or no trading in between. Gaps often take place outside regular trading hours. An example of a basic gap trading strategy is to find a stock that has gapped higher or lower, identify the range during the first hour of trading and then either buy when the price rises above the top of the range or sell when the price falls below the bottom of the range.

Moving averages and oscillators such as RSI and MACD are among the best indicators for day trading. Moving averages are helpful in identifying trends and oscillators show when momentum is strong and when it is beginning to fade. Volume (the total number of shares or contracts exchanged), is an important indicator for gauging the strength and significance of a price move. 

Keep in mind that day trading strategies do not have to be complicated. Some of the best day trading strategies have only a few rules or parameters.

Many newcomers want to know how to pick stocks for day trading. The best stocks for day trading are typically highly liquid, meaning that they can be bought and sold easily without impacting the price. Day traders can also benefit from major price movements, so another quality to look for is volatility. The more a financial instrument moves, the more opportunity there is for day traders. Stock screeners are available that can identify stocks above set price levels (which will weed out illiquid penny stocks) and stocks that regularly have high volatility.

The studies that have been made on the success rate of day traders are sobering. Evidence suggests that the majority of day traders fail, so it would be fair to say that for the majority it is not worth it. For the few that succeed and can endure the rigors of day trading, it can prove to be worth it, at least in financial terms.

Famous studies that have highlighted the difficulty of day trading include the following:

• Day Trading for a Living? In this study, researchers tracked day traders in the Brazilian equity futures market. They found that 97% of traders who persisted for over 300 days lost money.
• The cross-section of speculator skill: Evidence from day trading This long-term study of stock traders in Taiwan found that less than 1% of day traders were able to predictably and reliably earn positive abnormal returns net of fees.  

Having seen such statistics you might ask yourself if day trading is just gambling. While gambling is something usually done for pleasure, the odds of success in professional day trading are often not very different. Like gamblers, day traders should only risk money they can afford to lose.

Another point to remember is that when you make a profit from trading you have a capital gain, which in the UK typically results in a Capital Gains Tax if your total gains are above your allowance for the tax year.

While highly risky, day trading is legal. Traders must be careful in selecting brokers and be wary of loosely regulated or completely unregulated brokers that may be situated offshore and provide little or no legally mandated protection in the event of their insolvency. 

The rules differ in the United Kingdom and the United States; in the US an individual is designated as a Pattern Day Trader (PDT) if they execute four or more day trades in stocks and equity options over five business days using a margin account. Financial Industry Regulatory Authority (FINRA) rules require that Pattern Day Traders must have at least $25,000 in their margin accounts in order to day trade.

However, in the UK, the Pattern Day Trader rule doesn’t apply to anyone who trades with an FCA-regulated broker.