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Day trading is a form ofspeculation insecurities in which atrader buys and sells afinancial instrument within the sametrading day. This means that allpositions are closed before the market closes for the trading day to avoid unmanageable risks and negative price gaps between one day's close and the next day's price at the open. Traders who trade in this capacity are generally classified asspeculators. Day trading contrasts with the long-term trades underlyingbuy-and-hold andvalue investing strategies.[1][2] Day trading may require fast trade execution, sometimes as fast as milli-seconds in scalping, therefore direct-accessday trading software is often needed.[3]
Day trading is a strategy of buying and selling securities within the same trading day. According toFINRA, 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 useleverage such asmargin loans. In the United States,Regulation T permits an initial maximum leverage of 2:1, but many brokers will permit 4:1 intraday leverage as long as the leverage is reduced to 2:1 or less by the end of the trading day. In other countries margin rates of 30:1 or higher are available. In the United States, based on rules by theFinancial Industry Regulatory Authority, people who make more than three day trades per one five-trading-day period are termedpattern day traders and are required to maintain $25,000 in equity in their accounts.[6] However, a day trader with the legal minimum of $25,000 in their account can buy $100,000 (4× leverage) worth of stock during the day, as long as half of those positions are exited before the market close. Because of the high risk of margin use, and of other day trading practices, a day trader will often have to exit a losing position very quickly, in order to prevent a greater, unacceptable loss, or even a disastrous loss, much larger than their original investment, or even larger than their account value.[7]
Day trading was once an activity that was exclusive to financial firms and professional speculators. Many day traders arebank or investment firm employees working as specialists inequity investment andinvestment management. Day trading gained popularity after the deregulation of commissions in the United States in 1975, the advent ofelectronic trading platforms in the 1990s, and with the stock pricevolatility during thedot-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]
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 ofInstinet in 1969. However, at first, they generally offered better pricing to large traders.[12]
The next important step in facilitating day trading[citation needed] was the founding in 1971 ofNASDAQ - a virtual stock exchange on which orders were transmitted electronically.[13]
AfterBlack Monday (1987), the SEC adopted "Order Handling Rules" which required market makers to publish their best bid and ask on the NASDAQ.[14]
In the 1980s, the NASDAQ introduced theSmall Order Execution System (SOES).[15] The SOES became so popular among day traders that they were known as "SOES bandits".[15] The SOES system ultimately led to trading facilitated by software instead of market makers via ECNs.[16]
The ability for individuals to day trade viaelectronic trading platforms coincided with the extremebull market in technological issues from 1997 to early 2000, known as thedot-com bubble. From 1997 to 2000, the NASDAQ rose from 1,200 to 5,000. Many naive investors with little market experience made huge profits buying these stocks in the morning and selling them in the afternoon, at 400%margin rates. An unprecedented amount of personal investing occurred during the boom and stories of people quitting their jobs to day trade were common.[17]
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 byshort selling or playing on volatility.[18][19]
Because of the nature offinancial leverage and the rapid returns that are possible, day trading results can range from extremely profitable to extremely unprofitable; high-risk profiletraders can generate either huge percentage returns or huge percentage losses.[20]
Day trading is risky, and theU.S. Securities and Exchange Commission has made the following warnings to day traders:[21]
Most day traders lose money.[22][23][24]
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 Brazilian equity futures is almost uniformly unprofitable:
Considering the performance net of exchange and brokerage fees, we find that 97% of all investors who persisted for more than 300 days lost money. Only 17 individuals (1.1% of 1,551) earned more than the Brazilianminimum wage (US$16 per day), only eight individuals (0.5% of 1,551) earned more than the initial salary of abank teller (US$54 per day), and the individual who earned the most earned US$310 per day on average. Importantly, the eight individuals who earned more than the initial salary of a bank teller did so with great volatility: the standard deviation of the daily profit of these eight individuals ranges from US$632 to US$3,308.[25]
A 2017 article inForbes 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] tradersreally make money."[26]
Day trading requires a sound and rehearsed method to provide a statistical edge on each trade and should not be engaged on a whim.[27]
The following are several basictrading strategies by which day traders attempt to make profits. In addition, some day traders also usecontrarian investing strategies (more commonly seen inalgorithmic trading) to trade specifically against irrational behavior from day traders using the approaches below. It is important for a trader to remain flexible and adjust techniques to match changing market conditions.[28]
Swing trading is a trading strategy that involves holding a financial instrument for one or more days in an attempt to profit from price changes, or "swings".[29] While day trading focuses on intraday volatility and requires all positions to be closed before the market session ends, swing traders hold positions for several days to weeks.[30] This approach typically utilizes technical analysis to identify trends and patterns, but may also incorporate fundamental analysis to gauge a security's value. Compared with day trading, swing trading generally involves a lower frequency of trades, which may reduce transaction costs, but it also carries overnight risk, including the possibility of significant price gaps occurring while markets are closed.
Trend following, or momentum trading, is a strategy used in all trading time-frames, assumes thatfinancial instruments which have been rising steadily will continue to rise, and vice versa with falling. Traders can profit by buying an instrument which has been rising, orshort selling a falling one, in the expectation that the trend will continue. These traders usetechnical analysis to identify trends.[31]
Szakmary and Lancaster (2015)[32] 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.[33]
Contrarian investing is amarket timing strategy used in all trading time-frames. It assumes thatfinancial 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.[34]
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 aresistance price. That is, every time the stock hits a high, it falls back to the low, and vice versa. Such a stock is said to be "trading in a range", which is the opposite of trending.[35]
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.[31]
Scalping highly liquid instruments for off-the-floor day traders involves taking quick profits while minimizing risk (loss exposure).[36] 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.[37]
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 ECNspay 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.[38]
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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.[31]
It is estimated that more than 75% of stock trades in United States are generated byalgorithmic trading orhigh-frequency trading. The increased use of algorithms and quantitative techniques has led to more competition and smaller profits.[39]
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The numerical difference between the bid and ask prices is referred to as the bid–ask spread.[40] It can be viewed as an estimate oftransaction costs.[40]
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). Someday trading strategies attempt to capture the spread as additional, or even the only, profits for successful trades.[41]
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.[3]
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