What is day trading?

The lure of opportunity has drawn many individuals to financial markets to trade and invest in stocks, foreign currencies (forex), commodities and other asset classes.

Day trading, in particular, has attracted plenty of contenders for its fast pace. However, this short-term trading strategy is risky and difficult to master.

What does day trading mean and how does it work? We take a look at this type of trading below.

Key points

What is day trading?

Day trading is the buying and selling of stocks, foreign exchange, commodities and other assets or financial derivatives during a single trading session. Traders speculate on the movement in asset prices by employing various strategies.

Decades ago, day trading was undertaken only by investment firms, financial institutions, trading funds and brokerages. Today, online trading platforms have brought day trading to the palm of a retail investor’s hand.

According to US investment bank BNY Mellon, retail investors have become a “growing force to be reckoned with”. Their share of total equities traded went up to nearly 25% in 2021, from the 10% to 15% reported in the first decade of the 2000s.

For many retail investors, day trading has become a career. Others have burnt their hands trying to make profits from this risky and fast-paced short-term strategy.

Now that we have gone through the definition of day trading, let us read more about day traders, their techniques and strategies, and day trading examples.

Life of a day trader

An experienced day trader’s session will start hours before the market opens or the night before. The trader will take their time to analyse price charts, investor sentiment, corporate news, macroeconomic developments and more. 

As the stock market opens in the morning, some traders may sit on the sidelines in the first hour of a trading session to avoid the opening minutes that tend to be volatile. 

After the market settles, day traders spend the day scanning for market opportunities. Day traders usually stick to securities that they have experience with as they will be aware of the little intricacies regarding that particular security.

The day trader will open and close positions according to their price targets and risk tolerance. A trader’s setup may involve hedging to protect against unexpected losses.

Day trading is particularly popular with foreign exchange traders. Popular forex pairs have deep liquidity and tight spread, which allow day traders to speculate on small price movements.

Strategies used by day traders

To understand how day trading works, readers need to know about the various intraday strategies used by traders.

Scalping

Scalping involves a day trader aiming to speculate on small changes in an asset’s price. Traders place numerous short-lived scalp trading bets in a day so that small profits add up to a significant daily gain. Day traders need to implement a strict exit strategy to prevent large losses.

Range trading

Day traders are known for their use of technical analysis which involves identifying support and resistance price levels and analysing price trends, volume and volatility.

Range trading involves buying and selling of securities between a range of price where the top price is determined by the price resistance level and the bottom is determined by the price support level.

Algorithmic day trading

Algorithmic trading involves execution of trade orders based on pre-programmed instructions based on price, time and volume of a security.  

Algorithmic trading is extensively used by hedge funds and investment banks to carry out day trades in large orders at high speed. This is also known as high-frequency trading.

News-based day trading

The trader will set up his trade setup based on trading opportunities arising from expected corporate and macroeconomic developments.  An example of this type of day trading is anticipating a fall in broad markets before the publication of market-moving data such as inflation numbers or corporate earnings calls.
 

Day trading explained through examples

To better understand day trading, let’s look at the following example. Note that it is for educational purposes only and does not constitute investment advice.  

John is a self-taught day trader who has learnt the art of intraday trading over time through trial and error. He specialises in stock trading and is particularly interested in the US equity market. 

Over the years, John has traded Apple (APPL) shares extensively and is well-versed with developments at the iPhone maker. 

Before Apple’s fourth-quarter earnings announcement, John conducted a thorough research on Apple and concluded that the company will report strong revenue and profit growth.

John aimed to trade using news-based trading and range bound trading techniques on the day of the result announcement. 

The trader opened an intraday position with a target price of $155, based on identified resistance levels, and a stop-loss at $135, based on identified support levels for Apple shares trading at $145.

If Apple announces higher-than-expected earnings, which would cause the stock to rise to a level above $155, John will book profit. In case the company surprises on the downside, causing the stock price to fall, John’s position will automatically close when the price falls below $135, booking a loss. 

During the day, John will constantly monitor Apple’s intraday performance to react to unexpected market volatility and to adjust his profit-taking and stop-loss levels, according to real-time performance.

Final thoughts

Note that all trading contains risk of loss, and especially such a fast-paced strategy as day trading. Always conduct your own due diligence before opening a position, looking at the latest news, a wide range of analyst commentary, fundamental and technical analysis.

Remember, past performance does not guarantee future returns, and never trade more money than you can afford to lose.

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