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What is Day Trading? Research Team | Posted On Saturday, May 02,2009, 10:45 AM

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What is Day Trading?



What is Day Trading?

Day trading refers to the practice of buying and selling financial instruments within the same trading day such that all positions will generally be closed before the market close of the trading day. This is the reverse of After-hours trading. Traders that participate in day trading are known as Day Traders. Some of the more frequently day-traded financial instruments are stocks, stock options, currencies, and a host of futures contracts such as equity index futures, interest rate futures, and commodity futures.

Day trading used to be the preserve of financial firms and specialized investors and speculators. Many day traders are bank or investment firm employees working as experts in equity investment and fund management. However, day trading has become more and more popular among casual traders due to advances in technology, changes in legislation, and the popularity of the Internet.

Although collectively called day trading, there are several sub-trading styles within day trading. A day trader is not essentially very active. Depending on one's trading approach, the number of trades made in a day may vary from one to dozens or more. Some day traders focus on very short or short-term trading, in which a trade may last seconds to a few minutes. They buy and sell many times in a day, trading very high volumes daily and therefore receiving big discounts from the brokerage.

Several day traders focus only on momentum or trends. They are more patient and wait for a strong move in the market which may occur on that day. They make far less trades than the abovementioned traders.

Many day traders sell their positions before the market close of the trading day to avoid the risk of price gaps (differences between the previous day's close price and the next day's open price) at the open. Some day traders believe this to be a golden rule to be obeyed at all times. Other traders consider they should let the profits run, so it is acceptable to stay with a position after the market closes.

Day traders frequently borrow money to trade. Since margin interests are typically only charged on overnight balances, the extra expenses discourage them from holding positions overnight. Because of the nature of financial leverage and the quick returns that are possible, day trading can be either extremely profitable or extremely unprofitable, and high-risk profile traders can make either huge percentage returns or huge percentage losses. Some day traders manage to earn millions per year exclusively by day trading.

Because of the high profits or losses that day trading makes, traders are occasionally portrayed as "bandits" or "gamblers" by other investors. Some individuals, however, make a constant living day trading. Nevertheless, day trading can become very risky, particularly if one has poor discipline, risk or money management. The common use of buying on margin (using borrowed funds) magnifies gains and losses, such that substantial losses or gains can occur in a very short period of time. In addition, brokers usually allow larger margins for day traders.

Where overnight margins necessary to hold a stock position are normally 50% of the stock's value, many brokers allow pattern day trader accounts to use levels as low as 25% for intraday purchases. This means a day trader with the legal minimum Rs. 25,000 in his account can buy Rs. 100,000 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 his original investment, or even larger than his total assets.

Even when a position has made a profit, the trader has to compensate the transaction costs and the interest on the margin. It is usually stated that 80-90% of day traders lose money. An analysis of the BSE suggests that "less than 20% of day traders earn profits net of transaction costs".

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