Day Trading Basics

Since the introduction of electronic retail trading platforms in the late 1990s and early 2000s, Day Trading has become one of the more popular trading methods for many retail clients. But what exactly is Day Trading and how does it work?

Day Trading is simply buying and selling securities (stocks, futures, options, etc) during the same trading session, seeking to profit from small, short term price fluctuations. While investors tend to hold their stocks for years, most day traders own stocks for a matter of hours, minutes, or even seconds. And, most importantly, a day trader is always flat (no open positions) at the close of the market each and every trading day.

Most investors are concerned with the health and growth opportunities of the companies they buy; The primary focus of most day traders is a stock's recent price action . They tend to want to buy stocks that are climbing and sell stocks that are falling, riding short term trends and moving in and out of various stocks throughout the trading session. A company's business, profitability, price/earnings ratio, book value, etc, are largely irrelevant to day traders; They just want to be in stocks that are moving .

So which stocks do day trader's actually trade? The two most important stock selection criteria for most day traders are liquidity and volatility . The ideal stock for a day trader is one that is liquid (trades millions of shares per day) and has a wide average daily range (a day's high minus its low).

Liquidity is very important to day traders, as they do not wish their trading to affect the price level of the stock they are trying to buy or sell. Because they are looking for profits as little as $0.05 or even $0.01 per share, day traders tend to trade larger positions (usually 1000 shares at a time or more). Its important that there are enough shares available when a day trader wants to get in (and more importantly, when he wants to get out). Liquid stocks also tend to have narrow spreads (the difference between the current bid and ask price), usually one tick ($0.01 for stocks), so when a trader needs to get out, he knows he can do so for no more than a tick or so below the last traded price.

Volatility is also a big deal for day traders, since they are trading for such small price differences. They want stocks that tend to make large extended moves, which they hope to ride for as long as possible. The bigger the average move, the larger the average profit.

For the above reasons, many day traders focus on high volume Nasdaq stocks (i.e.: GOOG, AAPL, AMZN, etc) which are generally more volatile than stocks traded on other exchanges. They tend to offer faster executions than stocks traded on the NYSE, although this is less of a factor than in the past.

I'm sure you're wondering how day traders decide when to enter and exit a position. Well, there are probably as many styles of day trading as there are traders in the market, but here's a few of the more popular techniques:

Momentum

Momentum is simply entering a position in the direction of the current market movement and then riding the wave until it starts to reverse, usually for many minutes or even hours at a time. Momentum is a popular trend following technique as it is a fairly intuitive strategy. But in practice, it's much more difficult than it sounds; Stocks are inherently noisy and rarely move in a straight line for very long.

Scalping

Traders that move quickly in and out of positions are known as scalpers. Their technique is to look for very short term buying and selling flurries and jump on the trend and immediately exit for a very small profit, usually just a few ticks. They generally do this multiple times per day.

Grinders

Scalpers that trade for one or two ticks at a time are known as grinders, since they grind out profits in such small increments. They may make 20, 50, or even 100 trades each day. Many high frequency trading algorithms qualify use variations of grinding techniques, executing hundreds or thousands of trades per day.

News/Events

Many day traders are news traders who focus on stocks that are moving in response to news or earnings reports. A news trader might for example seek to short stocks that have had a negative earnings announcement. The idea is that a sudden event or announcement can cause investors to get irrational and panic, thereby creating strong, extended trends a day trader can ride.

The first step to becoming a successful day trader is to read as much material on the subject as you can. There are a huge number of trading books on the market, but before laying your money down, be sure to read the user reviews and look for books written by actual traders, rather than professional writers looking to make a quick buck.

There are also many trading forums on the Internet that can help you shorten your learning curve. Here are a few of the better ones:

• Elite Trader
• Baby Pips
• Forex Factory
• Trading Blox
• Big Mikes Trading Forum

I recommend visiting each of these and reading as many threads as you can before you place your first live trade.

Once you feel you are ready to trade, you'll obviously need to open a brokerage account. I'd recommend one of the following:

Interactive Brokers. IB is the brokerage of choice for many day traders, as they offer low per-share commission rates, fast executions, and a widest selection of markets to trade of any brokerage out there. Their trading platform (TWS) can be a bit intimidating at first and their customer support can be a bit terse at times, as they are more geared toward experienced traders. But they are one of the best brokerages out there, IMHO.

TD Ameritrade. TDA has been around for quite a while and their Think or Swim trading platform is one of the best and easiest to use and understand. They offer low per-trade commission rates and reasonably fast executions. Some traders complain that their quotes are not as reliable as they should be, but I've not experienced this myself.

There are many other brokerages out there, of course, but the above are the two standouts for day traders, IMHO.

Once you've opened your brokerage account, I'd advise that you fund it with as little money as possible. And before you enter your first live trade, I'd suggest you trade using a simulator to get a feel for the platform and trading in general (the above brokerages offer simulators at no additional charge). I'd also suggest that you stay on the simulator until you are consistently profitable and have built up enough confidence to trade with real dollars.

After you've trading with the simulator and feel you're ready to go live, you should start trading in small lots (100 shares or less), then gradually increase your size as (and if) you become profitable. Live trading with real dollars can be very different than trading on the simulator and emotions can run high when you've experienced a large loss or gain.

Day Trading is an extensive subject and can hardly be covered from beginning to end in a single article. But hopefully I've given you at least a taste of what Day Trading is about and a few nuts and bolts.

In closing I should stress that the importance of remembering that trading is a very competitive game and the odds of success are not in your favor. Like any skilled profession, it is not one that you can learn in a few day, weeks, or even months. My advice is to take it slow, risk no more money than you can afford to lose (odds are you will lose at first), and keep your emotions in check.

Good Luck!

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