Trading Tip #22: What is day trading?

Trading Tip #22: What is day trading?

Posted in the Day Trading Forum

Since: Mar 10

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#1 Jul 18, 2011
Day trading is probably one of the most misunderstood labels in the industry. Some people might picture a random trader acting like a cowboy just buying and selling with pure abandon. Others might imagine a seasoned vet pouring over charts and analysis, looking for a chance to try to scoop up a few points here or there. Let’s set the record straight on what day trading does – and doesn’t – entail.

Day trading is definitely not for the faint of heart.

Day trading is possible because of the great amount of leverage there is in the markets. The ability to buy or sell contracts that represent exponentially greater values than what is held in deposit in a trading account can mean the chance for big gains or even bigger losses. That is why a lot of day trading is thought of as gambling or a Wild West show.

There are a lot of traders out there who exclusively day-trade.

The mechanics to day trading are straightforward. You are in a trade and out of it in the same trading session. There is no “holding” the position overnight or through to the next session, looking for more potential profits. That is position trading. Why open a trading position and close it in the same session? There are a bunch of reasons that someone might cite, but the most obvious is that there is a different kind of exposure between trading sessions.

For a day trader, there is an inherent risk that the market may gap up or down and against an open position when trading begins in a new session. Picture some of the overnight or over the weekend financial bombshells that could be dropped. A couple of good examples are those nights when Asian markets have tumbled on their fundamentals and North American markets open much, much lower the next day. This would be a gap to the downside that would be a big negative to an open long position.

Closing things out before the session ends is a way that some traders try to avoid that kind of exposure.

So how do day trades work?

Most markets are a constant flux between buy orders and sell orders, and it is unlikely that a highly liquid market (one that has many buyers and sellers, making it relatively fluid to open and close positions) would stay at a constant price through a whole session. Day traders look to buy low, sell high and scoop up a few points to their benefit.

Trades can be based on:

- Identifying and trying to follow a trend

- Looking for technical signals that suggest a coming reversal and try to play a breakout

- Playing market movement off identified support or resistance

- Quick in-and-out trading strategies like scalping, where the trader tries to identify arbitrage opportunities where there is a price imbalance

- Any personal system a trader might use to try to identify trade opportunities

The last one on this list is becoming more common as trading moves into the electronic world. Programs on computers look for specific algorithms and other identifiers that may signal price action that a day trader can use to try to gain an advantage.
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