Day Trading: Definition, Risks and How to Start - NerdWallet (2024)

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Day trading means buying and selling securities rapidly — often in less than a day — in an attempt to profit off of short-term price movements.

If you're researching how to day trade, chances are you're intrigued by the prospect of turning quick profits in the stock market. Make no mistake: you're facing long odds and steep risks.

But even if you're just dabbling in the market with a few extra dollars, it's important to understand the basics so you don't get in over your head.

» Need to back up a bit? Learn to read stock charts

How to start day trading

When it comes to day trading, it’s best to go in with eyes wide open: while the potential for profits might be possible, the risks are real. As you enter the realm of day trading, here are some additional tips to consider:

  • Establish your strategy before you start. Losing money scares people into making bad decisions, and you have to lose money sometimes when you day trade. Having an exit plan for each of your investment holdings is important because it helps you avoid making an emotional decision when you need to make a rational decision.

  • Be patient. Look for trading opportunities that meet your strategic criteria. If the situation doesn’t meet it, don’t trade. You don’t have to trade if nothing looks attractive.

  • Read, read, read. Continually watch what’s happening in the markets. Big news — even unrelated to your investments — could change the whole tenor of the market, moving your positions without any company-specific news.

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» Wondering where to day trade? Review NerdWallet’s picks of the best brokers for day trading.

If you’re not quite ready to be a prime-time player, you can always try paper trading with a stock market simulator first. Paper trading involves fake stock trades, which let you see how the market works before risking real money. Paper trading accounts are available at many brokerages. You can also get a feel for the broker’s platform and functionality with this approach, in addition to seeing how theoretically profitable you'd be.

Day trading strategies

You'll need to determine the best trading strategy for you. You may wish to specialize in a specific strategy or mix and match from among some of the following typical strategies.

Range trading or swing trading

Traders find a stock that tends to bounce around between a low and a high price, called a "range bound" stock, and they buy when it nears the low and sell when it nears the high. They may also sell short when the stock reaches the high point, trying to profit as the stock falls to the low and then close out the short position.

Spread trading

This high-speed technique tries to profit on temporary changes in sentiment, exploiting the difference in the bid-ask price for a stock, also called a spread. For example, if a buyer’s bid price drops suddenly, the day trader might step in to buy and then try to quickly resell at the stock’s ask price or higher, earning a small “spread” on the transaction.

Fading

This sees a trader short-selling a stock that has gone up too quickly when buying interest starts to wane. The trader might close the short position when the stock falls or when buying interest picks up.

Momentum, or trend following

This strategy tries to ride the wave of a stock that’s moving, either up or down, perhaps to due to an earnings report or some other news. Traders will buy a rising stock or “fade” a falling one, anticipating that the momentum will continue.

How you execute these strategies is up to you. Some traders might angle for a penny per share, like spread traders, while others need to see a larger profit before closing a position, like swing traders. Some traders might be willing to hold overnight, while others won’t and prefer to maintain a neutral position in case bad news hits before they can react.

To know when to trade, day traders closely watch a stock’s order flow, the list of potential orders lining up to buy and sell a stock. Before buying, they’ll look for a stock to fall to “support,” a stock price at which other buyers step in to buy, and the stock is more likely to rise. To sell, they’ll look for when the stock hits “resistance,” a price where more traders start selling and the price is more likely to fall. To make judgments like this, you’ll want a broker that lets you see order flow.

Whichever strategy you pick, it's important to find one (or more) that work and that you have the confidence to use. It can take a while to find a strategy that works for you, and even then the market may change, forcing you to change your approach.

Day Trading: Definition, Risks and How to Start - NerdWallet (4)

How to day trade stocks

Stocks are among the most popular securities for day traders — the market is big and active, and commissions are relatively low or nonexistent. You can also day trade bonds, options, futures, commodities and currencies.

Typically, the best day trading stocks have the following characteristics:

  • Good volume. Day traders like stocks because they’re liquid, meaning they trade often and in high volume. Liquidity allows a trader to buy and sell without affecting the price much. Currency markets are also highly liquid.

  • Some volatility — but not too much. Volatility means the security's price changes frequently. This kind of movement is necessary for a day trader to make any profit. Someone has to be willing to pay a different price after you take a position.

  • Familiarity. You’ll want to understand how the security trades and what triggers moves. Will an earnings report hurt the company or help it? Is a stock stuck in a trading range, bouncing consistently between two prices? Knowing a stock can help you trade it. (Here’s how to research a stock.)

  • Newsworthiness. Media coverage gets people interested in buying or selling a security. That helps create volatility and liquidity. Many day traders follow the news to find ideas on which they can act.

Day traders who focus on stocks often rely on “technical analysis,” or analyzing the movements of stocks on a chart, rather than “fundamental analysis,” which involves examining company factors such as its products, industry and management. While some day traders might exchange dozens of different securities in a day, others stick to just a few — and get to know those well. This knowledge helps you gauge when to buy and sell, how a stock has traded in the past and how it might trade in the future.

» Read more: 5 steps to start trading stocks online

The best times to day trade

Day traders need liquidity and volatility, and the stock market offers those most frequently in the hours after it opens, from 9:30 a.m. to about noon ET, and then in the last hour of trading before the close at 4 p.m. ET.

As to the best time to trade for profitability, theories abound, but what can’t be disputed is the concentration of trades that bookend the regular market session. An analysis from the Jefferies Group showed that in 2018, 25% of average daily trading volume took place in the last 30 minutes of regular trading hours, excluding the closing auction, while 5.5% took place in the first 30 minutes.

A day trader might make 100 to a few hundred trades in a day, depending on the strategy and how frequently attractive opportunities appear. With so many trades, it’s important that day traders keep costs low — our online broker comparison tool can help narrow the options.

Day trading risk management

The above ground rules can help you avoid some of the biggest catastrophes in day trading, but it’s important to manage smaller risks, as well. Risk management is all about limiting your potential downside, or the amount of money you could lose on any one trade or position. When considering your risk, think about the following issues:

  • Position sizing. If the trade goes wrong, how much will you lose?

  • Percentage of your portfolio. Closely related to position sizing, how much will your overall portfolio suffer if a position goes bad?

  • Losses. What level of losses are you willing to endure before you sell?

  • Selling. After making a profitable trade, at what point do you sell?

Even with a good strategy and the right securities, trades will not always go your way. It’s important to have a plan for when to close a position, whether it's purely mechanical — for example, sell after it goes up or down X% — or based on how the stock or market is trading that day.

Proper risk management prevents small losses from turning into large ones and preserves capital for future trades. But that means traders have to be willing to realize a loss, which is hard for many traders to accept, even though it’s essential to long-term survival.

Bottom line: Is day trading right for you?

Day trading is just one way to approach the stock market — and it’s hardly worthwhile for most investors.

Conversely, investors who buy and hold low-cost index funds that track a broad market index like the could see higher returns over a long period. Historically, the S&P 500 has an annualized total return of about 10%, not accounting for inflation.

If you're going to day trade, It's paramount to set aside a certain amount of money you can afford to lose. Don’t trade more than that amount or use the mortgage or rent money.

Here are some resources that will help you weigh less-intense and simpler approaches to growing your money:

  • NerdWallet’s guide on how to invest money.

  • Learn how to buy stocks.

  • Our round-up of the best brokers for stock trading.

Frequently asked questions

What is the pattern day trader rule?

If you execute four or more day trades — that is, trades in which you buy and sell a security the same day — within a five-business-day period, and those trades represent more than 6% of your total trades in that period, you'll be designated as a pattern day trader.

That means you'll have to maintain a minimum equity level of $25,000 in your margin account any time you day trade. That $25,000 can consist of cash, securities or both. You also may have your buying power restricted.

Why is day trading controversial?

The Securities and Exchange Commission (SEC) says that day traders "typically suffer severe financial losses in their first months of trading, and many never graduate to profit-making status."

That doesn't mean day trading is inherently a bad thing — if you have leftover "play money" after paying your bills and meeting your savings goals, and you want to try your hand at day trading with the knowledge that you might lose that money, that's fine.

But the SEC explicitly says that day traders "should never use money they will need for daily living expenses, retirement, take out a second mortgage, or use their student loan money for day trading."

Day Trading: Definition, Risks and How to Start - NerdWallet (2024)

FAQs

What is the 3 5 7 rule in trading? ›

What is the 3 5 7 rule in trading? A risk management principle known as the “3-5-7” rule in trading advises diversifying one's financial holdings to reduce risk. The 3% rule states that you should never risk more than 3% of your whole trading capital on a single deal.

How much money do day traders with $10000 accounts make per day on average? ›

With a $10,000 account, a good day might bring in a five percent gain, which is $500. However, day traders also need to consider fixed costs such as commissions charged by brokers. These commissions can eat into profits, and day traders need to earn enough to overcome these fees [2].

What is day trading and what are the risks? ›

Bottom Line Up Front. Day trading is buying and selling stock on the same day, hoping to make money in a short time by watching prices closely. Tax consequences and other risks can result from day trading – your profits are liable for a short-term capital gain tax at the income tax level you fall under.

Why do you need $25,000 to day trade? ›

Ultimately, the purpose of the $25,000 minimum equity requirement is to ensure that day traders have enough capital to cover their potential losses and to prevent market manipulation. It also protects brokers from financial risks and helps maintain the stability of the trading industry.

What is 90% rule in trading? ›

The 90 rule in Forex is a commonly cited statistic that states that 90% of Forex traders lose 90% of their money in the first 90 days. This is a sobering statistic, but it is important to understand why it is true and how to avoid falling into the same trap.

What is No 1 rule of trading? ›

Rule 1: Always Use a Trading Plan

You need a trading plan because it can assist you with making coherent trading decisions and define the boundaries of your optimal trade. A decent trading plan will assist you with avoiding making passionate decisions without giving it much thought.

Can I make $100 a day day trading? ›

You're really probably going to need closer to 4,000 or $5,000 in order to make that $100 a day consistently. And ultimately it's going to be a couple of trades a week where you total $500 a week, so it's going to take a little bit more work.

Can you make $200 a day day trading? ›

A common approach for new day traders is to start with a goal of $200 per day and work up to $800-$1000 over time. Small winners are better than home runs because it forces you to stay on your plan and use discipline. Sure, you'll hit a big winner every now and then, but consistency is the real key to day trading.

What should you not do in day trading? ›

What Should You Not Do in Day Trading?
  • Don't trade without a plan: It is critical to have a well-defined trading plan before entering any trade. ...
  • Don't overtrade: One of the most common mistakes made by day traders is placing too many trades in a short period of time, which is also known as overtrading.

What makes day trading illegal? ›

If your account value falls below $25,000, then any pattern day trader activities may constitute a violation. If you trade futures, keep in mind that futures cash or positions do not count toward the $25,000 minimum account value.

What does Warren Buffett think of day trading? ›

A classic Buffett quote indicates that he is no fan of day trading: “If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes.” This emphasis on holding a position for the long term means a very low level of trading activity.

What is the 10 am rule in stock trading? ›

Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour. For example, if a stock closed at $40 the previous day, opened at $42 the next, and reached $43 by 10 a.m., this would indicate that the stock is likely to remain above $42 by market close.

Is it illegal to day trade with less than 25k? ›

You can day trade without $25k in accounts with brokers that do not enforce the Pattern Day Trader rule, which typically applies to U.S. stock markets. Consider forex or futures markets, which have different regulations and often lower entry barriers for day trading.

Is it legal to buy and sell the same stock repeatedly? ›

How often can you buy and sell the same stock? You can buy and sell the same stock as often as you like, provided that you operate within the restrictions imposed by FINRA on pattern day trading and that your broker allows it.

What is the 60 30 10 rule in trading? ›

This reinventive basic rule to portfolio structure means allocating 60% to equities, 30% to bonds, and 10% to alternatives. The exact percentages may vary by portfolio, but the key idea is that Alternatives should be an integral part of every portfolio, in some percentage.

What is the 80 20 rule in trading? ›

In investing, the 80-20 rule generally holds that 20% of the holdings in a portfolio are responsible for 80% of the portfolio's growth. On the flip side, 20% of a portfolio's holdings could be responsible for 80% of its losses.

What is the golden rule of traders? ›

Let profits run and cut losses short Stop losses should never be moved away from the market. Be disciplined with yourself, when your stop loss level is touched, get out. If a trade is proving profitable, don't be afraid to track the market.

What is the 3 30 rule in trading? ›

This rule suggests that a stock's price tends to move in cycles, with the first 3 days after a major event often showing the most significant price change. Then, there's usually a period of around 30 days where the stock's price stabilizes or corrects before potentially starting a new cycle [1].

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