Day traders focus purely on the market action in a single day. This means they close out their positions at the end of the day. They tend not to hold overnight positions.
This makes them very different from investors, who can hold onto a share for years, or swing traders, who are more short term opportunists, but are still thinking in terms of days, weeks, or months.
Day trading for beginners
Because of its short term nature, day trading can reduce the risk of losses occurring overnight, when you are asleep. If you are disciplined, if you close all your positions, then you are protected until the next time you enter the market.
Remember, just because a share is listed on the stock exchange does not mean some bad news affecting that share price may not occur during the night, or indeed before the market opens in the morning.
The downside is that your trades have to work for you inside the space of a single day. There is no tomorrow. Over the long term, the efficiency of financial markets means that prices will reflect all the information about a given security, but you may not see the benefits of this on just one day.
Day Traders are speculators, not hedgers
Hedgers are traders that are looking to trade to protect the value of other assets. This can be as simple as a portfolio manager using Contracts for Difference to protect the possible losses in the value of his shares, to a farmer who uses the agricultural futures market to protect himself against a drop in crop prices.
Speculators, by contrast, are looking to make money from the market as they see it today.
Day traders are speculators – they manage risk by using stop loss and limit orders, and by closing out at the end of the day, but they do not seek to protect value like hedgers do. It is important, however, for day traders to understand who else is in the market and why.
This is because trading in a market during a single day is a zero sum game – you only make money if someone else is losing it. The other market participant may have a much longer term time scale than you do, and won’t mind losing that money on a given day, but to be a successful day trader, you need to have a proper understanding of zero sum markets, and that is not necessarily the same as conventional investment finance.
What is a zero sum market?
These are markets where success is measured purely in whether you win or lose. There is no such thing as a net gain. You are either up or down for the day. Many day traders favour options, futures, CFDs and financial spread bets. To be consistently up on the day, however, means that your counter party, the person or the institution on the other side of your trade, is going to be down.
To win consistently, of course, is the key to day trading. You cannot rely on luck. You need both a trading plan and the discipline to stick to it. You cannot allow emotions, like hope, fear or geed get the better of you in day trading.
Ignore the long term trends in the economy and the stock market – these are not for the day trader; growth in the economy can lead to more winners than losers in stocks, but you don’t get this in day trading.
Discipline is vital for the successful day trader
It really is all about discipline: the discipline to stick to your trading plan, the discipline to close out your positions every night. The market is not your friend, and the market is not going to cut you any slack because you have a hangover or had an argument with your wife/husband.
A proper business plan and a clear trading strategy are absolute essentials in this game. This includes having the discipline to set your working days and hours and sticking to that. The market is not something you can drop in and out of at your leisure.
Day trading cannot be done on the side – this misconception makes the disciplined traders, the 20%, the successful ones, very wealthy, because they make money while the other 80% lose.
And this is also why many people lose.
That is not to say that it is impossible to be a successful part-time day trader – but if you are going to trade part-time, then pre-determine what that part-time will look like. If you decide to trade three mornings a week, trade three mornings a week and close out at lunchtime. DON’T then be tempted to trade the odd afternoon when you have a winning position.
Imagine yourself working in a part-time job: that employer will set your expected hours. Stick to those religiously. Don’t do overtime.
Find the hours that fit your schedule and commit to those hours. Make sure you have a proper work space with high speed internet. Try if you can not to trade from the sofa, in front of the television, or at the kitchen table, where there are distractions.
Day trading is serious business. Don’t trade on your mobile while commuting into work. This is how you will lose your money.
Day trading is not a hobby either
Brokers and trading coaches will sometimes make it seem that trading is something you can easily fit around a busy schedule, like so much else in this life.
It is not.
To be a successful day trader, you need to commit to it as if it really was a job. Even then, many day traders fail to make a profit in the first year.
Don’t let it be you.
Come back soon for our next installment in this series on day trading.