Day Trading 101
Day trading is often misunderstood to be synonymous with investing. Where investing is the act of expending money with the goal of profiting by way of appreciation, day trading has a narrower definition. It means the buying and selling of stocks within a single trading day. Profits are made not through general appreciation, but rather through technical means using leverage to amplify small price discrepancies.
The trader who specializes in day trading watches mainly for one thing: volatility. The more an asset fluctuates in price, the higher chances of it becoming undervalued or overvalued and the room there is for profitable trading.
In order to take advantage of those tiny differences in price, day traders typically use leverage by way of margin accounts. This allows them to control greater amounts of an asset but it comes with a much higher degree of risk than investing. Margin trading amplifies both gains and losses so day traders need to have a sufficient amount of capital set aside in order to withstand losses.
Because of the vital need to time the market, computers are usually used to make trades. Algorithms designed to spot temporary pricing inefficiencies allow day traders to make multiple transactions in a variety of assets in a given day giving rise to the prevalence of quantitative finance.
While typical investors analyze assets using fundamental analysis, day traders rely elusively on technical analysis. The ability to spot trends in momentum, volumes, and other chart related indicators is essential in understanding how to day trade.
The Advantages of Day Trading
Day trading eliminates the need for thorough financial analysis and time-intensive research. Mathematical models base trades off of predetermined patterns throughout the day making it largely a hands-off approach.
One big advantage day traders have is the ability to profit equally in any type of market. Regardless of the general direction of the economy, day trading uses strategies like buying long or selling short when as asset moves out of its previously established pattern. Recessions provide just as many opportunities for profitable trading as booms making it a strategy for any type of economic season.
The Disadvantages of Day Trading
The ability to handle a high amount of risk is necessary to day trade. For investors who don’t want to see a large amount of volatility in their holdings, day trading is an inappropriate strategy. The need to have a large amount of money liquid is also an important key to success for day traders. Investors who don’t have a lump sum of cash on hand could be squeezed out of the market quickly without the ability to ride out losses.
Financial analysis gives investors the tools to understand companies that may outperform its peers or macroeconomic trends that may be occurring so that they can profit off of the long term value created. Day trading ignores long term fundamentals in favor of quick, temporary price adjustments. Traders that have a long term strategy in mind such as saving for retirement or a large purchase such as a home should consider investing rather than day trading.