Day trading
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Day trading is a form of
Day trading is a strategy of buying and selling securities within the same trading day. According to FINRA, a 'day trade' involves the purchase and sale (or sale and purchase) of the same security on the same day in a margin account, covering a range of securities including options. An individual is considered a 'pattern day trader' if they execute four or more day trades within five business days, given these trades make up over six percent of their total trades in the margin account during that period[4]. Pattern day traders must adhere to specific margin requirements, notably maintaining a minimum equity of $25,000 in their trading account before engaging in day trading activities[5].
Day traders generally use
Some of the more commonly day-traded
Day trading was once an activity that was exclusive to financial firms and professional speculators. Many day traders are bank or investment firm employees working as specialists in equity investment and investment management. Day trading gained popularity after the deregulation of commissions in the United States in 1975, the advent of electronic trading platforms in the 1990s, and with the stock price volatility during the dot-com bubble.[8] Recent 2020 pandemic lockdowns and following market volatility has caused a significant number of retail traders to enter the market.[9]
Day traders may be professionals that work for large financial institutions, are trained by other professionals or mentors, do not use their own capital, or receive a base salary of approximately $50,000 to $70,000 as well as the possibility for bonuses of 10%–30% of the profits realized.[10] Individuals can day trade with as little as $100,[11] or even less, with fractional shares.
History
Before 1975, stockbrokerage commissions in the United States were fixed at 1% of the amount of the trade, i.e. to purchase $10,000 worth of stock cost the buyer $100 in commissions and same 1% to sell and traders had to make over 2% to cover their costs, which was not likely in a single trading day.
In 1975, the U.S. Securities and Exchange Commission (SEC) prohibited fixed commission rates, and commission rates dropped significantly.
Electronic communication networks
Electronic communication networks (ECNs), large proprietary computer networks on which brokers can list a certain amount of securities to sell at a certain price (the asking price or "ask") or offer to buy a certain amount of securities at a certain price (the "bid"), first became a factor with the launch of Instinet in 1969. However, at first, they generally offered better pricing to large traders.[12]
The next important step in facilitating day trading was the founding in 1971 of
These developments heralded the appearance of "
After Black Monday (1987), the SEC adopted "Order Handling Rules" which required market makers to publish their best bid and ask on the NASDAQ.[13]
Another reform made was the "
In the late 1990s, existing ECNs began to offer their services to small investors. New ECNs arose, most importantly Archipelago (NYSE Arca) Instinet, SuperDot, and Island ECN. Archipelago eventually became a stock exchange and in 2005 was purchased by the NYSE.
The ability for individuals to day trade via
In March 2000, this bubble burst, and many less-experienced day traders began to lose money as fast, or faster, than they had made during the buying frenzy. The NASDAQ crashed from 5000 back to 1200; many of the less-experienced traders went broke, although obviously it was possible to have made a fortune during that time by
In parallel to stock trading, starting at the end of the 1990s, several new
Profitability and risks
Because of the nature of financial leverage and the rapid returns that are possible, day trading results can range from extremely profitable to extremely unprofitable; high-risk profile traders can generate either huge percentage returns or huge percentage losses.[18]
Day trading is risky, and the U.S. Securities and Exchange Commission has made the following warnings to day traders:[19]
- Be prepared to suffer severe financial losses
- Day traders do not "invest"
- Day trading is an extremely stressful and expensive full-time job
- Day traders depend heavily on borrowing money or buying stocks on margin
- Don't believe claims of easy profits
- Watch out for "hot tips" and "expert advice" from newsletters and websites catering to day traders
- Remember that "educational" seminars, classes, and books about day trading may not be objective
- Check out day trading firms with your state securities regulator
Most day traders lose money.[20][21][22]
A 2019 research paper analyzed the performance of individual day traders in the Brazilian equity futures market. Based on trading records from 2012 to 2017, it was concluded that day trading is almost uniformly unprofitable:
We show that it is virtually impossible for individuals to compete with HFTs and day trade for a living, contrary to what course providers claim. We observe all individuals who began to day trade between 2013 and 2015 in the Brazilian equity futures market, the third in terms of volume in the world, and who persisted for at least 300 days: 97% of them lost money, only 0.4% earned more than a bank teller (US$54 per day), and the top individual earned only US$310 per day with great risk (a standard deviation of US$2,560). We find no evidence of learning by day trading.[23]
An article in Forbes quoting someone from an educational trading website stated that "the success rate for day traders is estimated to be around only 10%, so ... 90% are losing money," adding "only 1% of [day] traders really make money."[24]
Techniques
Day trading requires a sound and rehearsed method to provide a statistical edge on each trade and should not be engaged on a whim.[25]
The following are several basic
Some of these approaches require
Swing Trading
Swing trading is a strategy aimed at gaining profit from stock price fluctuations over a period of several days to weeks. This method contrasts with day trading, where positions are closed within the same day. Swing traders utilize technical analysis to identify potential price movements and determine optimal trading moments. Key resources include Harry Boxer's "Profitable Day and Swing Trading,"[27] and John Crane's "Advanced Swing Trading: Strategies to Predict, Identify, and Trade Future Market Swings,"2[28] both of which discuss techniques such as price/volume surges and pattern recognition.
Trend following
As a Strategy for Day Trading, a robust trading strategy traditionally used for long-term investments in various asset classes, can also be adapted for day trading. This strategy, which benefits from identifying and leveraging market trends, involves clearly defined entry and exit points based on the prevailing market direction.
Szakmary and Lancaster (2015)[30] validate the effectiveness of trend following in the U.S. stock market, demonstrating its potential for generating positive returns. Similarly, research by Blackstar Funds highlights rigorous applications of trend following in commodities, financial futures, and currencies, although its application to stock trading presented challenges.[31]
For day traders, trend following requires rapid execution and diligent risk management, given the shorter time frame and higher transaction costs. Effective day trading using trend following strategies involves real-time trend analysis and the ability to quickly adjust to market changes.
Contrarian investing
Contrarian investing is a market timing strategy used in all trading time-frames. It assumes that financial instruments that have been rising steadily will reverse and start to fall, and vice versa. The contrarian trader buys an instrument which has been falling, or short-sells a rising one, in the expectation that the trend will change.[32]
Range trading
Range trading, or range-bound trading, is a trading style in which stocks are watched that have either been rising off a support price or falling off a
Scalping
Scalping was originally referred to as spread trading. Scalping is a trading style where small price gaps created by the bid–ask spread are exploited by the speculator. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds.[29]
Scalping highly liquid instruments for off-the-floor day traders involves taking quick profits while minimizing risk (loss exposure).[34] It applies technical analysis concepts such as over/under-bought, support and resistance zones as well as trendline, trading channel to enter the market at key points and take quick profits from small moves. The basic idea of scalping is to exploit the inefficiency of the market when volatility increases and the trading range expands. Scalpers also use the "fade" technique. When stock values suddenly rise, they short sell securities that seem overvalued.[35]
Rebate trading
Rebate trading is an equity trading style that uses ECN rebates as a primary source of profit and revenue. Most ECNs charge commissions to customers who want to have their orders filled immediately at the best prices available, but the ECNs pay commissions to buyers or sellers who "add liquidity" by placing limit orders that create "market-making" in a security. Rebate traders seek to make money from these rebates and will usually maximize their returns by trading low priced, high volume stocks. This enables them to trade more shares and contribute more liquidity with a set amount of capital, while limiting the risk that they will not be able to exit a position in the stock.[36]
Trading the news
The basic strategy of trading the news is to buy a stock which has just announced good news, or short sell on bad news. Such events provide enormous volatility in a stock and therefore the greatest chance for quick profits (or losses). Determining whether news is "good" or "bad" must be determined by the price action of the stock, because the market reaction may not match the tone of the news itself. This is because rumors or estimates of the event (like those issued by market and industry analysts) will already have been circulated before the official release, causing prices to move in anticipation. The price movement caused by the official news will therefore be determined by how good the news is relative to the market's expectations, not how good it is in absolute terms.
Price action trading
Price action trading relies on technical analysis but does not rely on conventional indicators. These traders rely on a combination of price movement, chart patterns, volume, and other raw market data to gauge whether or not they should take a trade. This is seen as a "minimalist" approach to trading but is not by any means easier than any other trading methodology. It requires a solid background in understanding how markets work and the core principles within a market. However, the benefit for this methodology is that it is effective in virtually any market (stocks, foreign exchange, futures, gold, oil, etc.).
Market-neutral trading
Market-neutral trading is a strategy that is designed to mitigate risk in which a trader takes a long position in one security and a short position in another security that is related.[29]
Algorithmic trading
It is estimated that more than 75% of stock trades in United States are generated by algorithmic trading or high-frequency trading. The increased use of algorithms and quantitative techniques has led to more competition and smaller profits.[37] Algorithmic trading is used by banks and hedge funds as well as retail traders. Retail traders can buy commercially available automated trading systems or develop their own automatic trading software.
Cost
Commission
Spread
The numerical difference between the bid and ask prices is referred to as the
The ask prices are immediate execution (market) prices for quick buyers (ask takers) while bid prices are for quick sellers (bid takers). If a trade is executed at quoted prices, closing the trade immediately without queuing would always cause a loss because the bid price is always less than the ask price at any point in time.
The bid–ask spread is two sides of the same coin. The spread can be viewed as trading bonuses or costs according to different parties and different strategies. On one hand, traders who do NOT wish to queue their order, instead paying the market price, pay the spreads (costs). On the other hand, traders who wish to queue and wait for execution receive the spreads (bonuses). Some day trading strategies attempt to capture the spread as additional, or even the only, profits for successful trades.[38]
Market data
Market data is necessary for day traders to be competitive. A real-time data feed requires paying fees to the respective stock exchanges, usually combined with the broker's charges; these fees are usually very low compared to the other costs of trading. The fees may be waived for promotional purposes or for customers meeting a minimum monthly volume of trades. Even a moderately active day trader can expect to meet these requirements, making the basic data feed essentially "free". In addition to the raw market data, some traders purchase more advanced data feeds that include historical data and features such as scanning large numbers of stocks in the live market for unusual activity. Complicated analysis and charting software are other popular additions. These types of systems can cost from tens to hundreds of dollars per month to access.[39]
See also
References
- ^ Yell, Tyler (October 3, 2019). "The Similarities Between Day Trading and Gambling". The Balance.
- ^ Frankel, Matthew (August 24, 2017). "Why Day Trading Stocks Is Not the Way to Invest". The Motley Fool.
- ^ SETH, SHOBHIT (August 17, 2019). "Choosing the Right Day-Trading Software". Investopedia.
- ^ https://www.sec.gov/oiea/investor-alerts-and-bulletins/margin-rules-day-trading
- ^ Bulkowski, T. N. (2013). Swing and day trading evolution of a trader. In Swing and day trading evolution of a trader (1st edition). Wiley.
- ^ "Day Traders: Mind Your Margin". Financial Industry Regulatory Authority.
- ^ "Day-Trading Margin Requirements: Know the Rules". Financial Industry Regulatory Authority. Archived from the original on 2019-04-16. Retrieved 2017-09-06.
- ^ Karger, Gunther (August 22, 1999). "Daytrading: Wall Street's latest, riskiest get-rich scheme". American City Business Journals.
- ^ Davis, Anthony A. (2021). "The life of a pandemic day trader".
- ^ Godfrey, Neale (July 16, 2017). "Day Trading: Smart Or Stupid?". Forbes.
- ^ Diamandiev, Damyan (May 26, 2020). "How to Become a Day Trader with $100". Benzinga.
- ^ "Instinet - A Nomura Company - History". www.instinet.com. Archived from the original on 2019-03-21. Retrieved 2019-03-21.
- ^ Patterson, Scott (September 13, 2010). "Man Vs. Machine: How the Crash of '87 Gave Birth To High-Frequency Trading". CNBC.
- ^ Goldfield, Robert (May 31, 1998). "Got $50,000 extra? Put it in day trading". American City Business Journals.
- ^ Kadlec, Daniel (August 9, 1999). "Day Trading: It's a Brutal World". Time.
- ^ Nakashima, David (February 11, 2002). "It's back to day jobs for most Internet 'day traders'". American City Business Journals.
- ^ Hayes, Adam (June 25, 2019). "Dotcom Bubble Definition". Investopedia.
- ^ KUEPPER, JUSTIN (August 11, 2020). "Day Trading: An Introduction". Investopedia.
- ^ "Day Trading: Your Dollars at Risk". U.S. Securities and Exchange Commission. April 20, 2005.
- ^ MITCHELL, CORY (February 12, 2020). "The Difficulties of Making Money by Day Trading". The Balance.
- S2CID 7979781.
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- SSRN 3423101.
- ^ Godfrey, Neale (July 16, 2017). Day Trading: Smart Or Stupid? Forbes.
- ^ MITCHELL, CORY (July 22, 2020). "Weighing a Day Trading Career". The Balance.
- SFO Magazine. October 2009.
- ^ Boxer, Harry. "Profitable Day and Swing Trading." John Wiley & Sons, Incorporated, 2014
- ^ Boxer, Harry. Profitable Day and Swing Trading : Using Price / Volume Surges and Pattern Recognition to Catch Big Moves in the Stock Market, John Wiley & Sons, Incorporated, 2014. ProQuest Ebook Central, https://ebookcentral.proquest.com/lib/kentucky-ebooks/detail.action?docID=1740478.
- ^ a b c Duggan, Wayne (December 21, 2018). "4 Popular Day Trading Strategies for Investors". U.S. News & World Report.
- ^ Szakmary, A. C., & Lancaster, M. C. (2015). Trend-Following Trading Strategies in U.S. Stocks: A Revisit. Financial Review, 50(2), 221–255. https://doi.org/10.1111/fire.12065
- ^ https://myhedgedfund.typepad.com/files/does_trendfollowing_work_on_stocks-2.pdf
- ^ CHEN, JAMES (March 6, 2019). "Contrarian". Investopedia.
- ^ CHEN, JAMES (May 4, 2018). "Trading Range". Investopedia.
- ^ Norris, Emily (September 1, 2020). "Scalping: Small Quick Profits Can Add Up". Investopedia.
- ^ "Type of Day Trader". DayTradeTheWorld. 15 January 2021.
- ^ Blodget, Henry (May 4, 2018). "The Latest Wall Street Trading Scam That Costs You Billions". Business Insider.
- ^ Duhigg, Charles (November 23, 2006). "Artificial intelligence applied heavily to picking stocks - Business - International Herald Tribune". The New York Times.
- ^ Milton, Adam (July 29, 2020). "Large Bid and Ask Spreads in Day Trading Explained". The Balance.
- ^ SETH, SHOBHIT (February 25, 2018). "Choosing the Right Day-Trading Software". Investopedia.