What is Day Trading?

What is Day Trading?

Reading time: 7 minutes

Day trading, or intraday trading activity, represents buying and selling financial assets over short-term periods; traders tend to liquidate their positions before the day’s close, which for currency traders is generally 5 pm New York (EST). Instead of targeting long-term gains, day traders navigate shorter-term price action and attempt to bank short-term returns. Day traders often trade across multiple asset classes, including currencies (think currency pairs), individual shares on the stock market, commodities, and cryptocurrencies.

Some day traders will hold a trade for most of the trading day, whilst others might only have a trade open for 30 minutes, sometimes even less (though at this point, it would be considered scalping). On the other hand, holding a position open overnight would be viewed as more of a swing trading approach and possibly, if held long term, even a position trade (investment style of trading [long-term investing]).

How Does Day Trading Work?

Day trading involves interacting with the market daily. Day trading essentially revolves around a key concept: volatility. This represents the movement or fluctuation in the price of any given security from a given mean (or average value) and is considered a proxy for risk. This is why risk management is one of the key components needed to day trade successfully. A security possessing increased volatility will be considered a riskier asset, though at the same time, potentially paving the way for greater returns. Void of volatility, prices would not move, and day traders (any type of directional trader, for that matter) would find it difficult to generate returns.

Short-term traders will generally monitor economic data for the day ahead, as potentially highly impacting risk events can cause a marked shift in the asset’s price and perhaps open the door to trading opportunities. Economic announcements such as interest rate decisions, growth data (GDP), employment figures, corporate earnings, and geopolitical events can cause notable sentiment shifts. Day traders need to have the ability to react to these events to exploit any price change, with traders frequently employing both technical and fundamental analysis to identify such change.

Liquidity is equally important for successful day trading, which refers to the ability of a trader to buy and sell a particular asset. For investors to sell (buy), there must be buyers (sellers). A market with thin liquidity can also give rise to slippage: a position executed at a different price compared to the desired price.

Through the derivatives market, traders can also use futures and options contracts and CFDs (Contracts for Differences) to speculate on short-term price action. Do take into account that by trading derivatives contracts, the trader generally does not take ownership of the underlying asset (although this is possible at the settlement date for futures and options, though all CFDs are cash settled). Consider exploring the CFD products offered by FP Markets, a one-stop destination to trade CFDs across Forex, Shares, Indices, Commodities, Digital Currencies, Bonds and ETFs (exchange-traded funds).

Day Trading vs Investing

One key difference between day trading and investing is time consumption. Day trading strategies require attention to charts and due diligence regarding technical analysis as well as a keen understanding of (potential) high-impacting economic data (sometimes referred to as tier-1 and tier-2 data) that are released daily.

Investments are seen as longer-term positions, with short-term price fluctuations largely disregarded. For example, you might buy shares in Apple based on its strong economic moat and its likelihood to grow over the next 5 years. On the other hand, day traders would look at price movement over a much shorter period, seeking bouts of volatility where returns can potentially be made more frequently.

Final Thoughts

Day trading has grown in popularity due to available access to the markets for worldwide investors. The growth of web-trading platforms and financial brokers has meant lower barriers to entry and more people becoming traders due to the ability to invest.

The reality, however, is that day trading requires effort and time to succeed consistently. Professional day traders acknowledge the importance of having a well-defined trading plan, devotion to perfecting trading strategies, risk management, money management and the need for a complete understanding of trading psychology.

 

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