What is day trading?

What is day trading?

Day Trading
Photo by @RLTheis

Day trading is just as it sounds, it’s when you trade within a ‘trading day’. This basically means that you would open and close a position on the same day. 

It doesn’t really matter at what time during the day but in theory, you should have closed it by the time you finish trading for the day.

It wouldn’t matter if the trade had not hit either your target or stop loss, you would still close it. The main reason traders stick to day trading is because they don’t feel comfortable holding a position overnight.

Day trading tends to be seen as a full-time job because you’re required to be at your screens regularly, looking for trading opportunities as well as monitoring your positions.

That being said, you can still take a trade in the morning and then come back at the end of the day to close it. Therefore meaning you can do other activities during the day, either a job or other leisure activities.

How to day trade

As we’ve mentioned, day trading is just as it sounds. It involves opening a trade and closing it on the same day. That’s not to say that you can only open one trade, you can open as many as you like.

An important element when it comes to day trading is being ‘flat’ at the end of the day. This simply means that you have no open positions and therefore no open risk.

How do you day trade? Ensure that you open and close your positions on the same day. Learning how to take a trade will depend on the trading platform you use, check out our MT4 tutorials, to understand how to day trade using MT4.

Why is day trading important?

Day trading is important because it provides a huge amount of liquidity to the financial markets. Not only retail traders but the institutional traders that day trade also contribute enormously to the volume that goes through the market.

This liquidity benefits all participants of the financial markets because it means that it’s easier to enter and exit positions at the intended price. If there were no day traders, it would be a lot more difficult to get the prices you want.

Day trading is also important for those who want to take advantage of every single move rather than just the underlying trend. If the underlying trend was going up but short term there was an opportunity to sell, day trading allows you to take advantage of these small but profitable moves.

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Is day trading hard?

Day trading is hard. Don’t let anyone fool you into saying otherwise. It’s often thought as the pinnacle of trading because it’s likely your full-time job.

If you’re day trading then you’re likely trading for a living. The majority of your time will be spent looking through the markets each day looking for opportunities, and therefore holding down another job would be difficult.

What’s required to be a successful day trader?

You need to be dedicated and have a good understanding of trading and risk. You need to be confident in your trading strategy and also understand your psychology. This will play a huge role in your success.

When day trading, you will have bad days, weeks and months. But if you stick to your plan, you will know that over time, you will be successful. Therefore persevering is important.

As mentioned, it is pretty much a full-time job. Analysing the markets and looking for trading opportunities. Using different strategies and ensuring that you only have the correct amount at risk at any one time.

What you shouldn’t do

Veer from your strategy – You shouldn’t get nervous about your strategy. If you stop taking trades because you have lost confidence then you could well miss the profitable trades which ensure your strategy is successful. Therefore sticking to the original plan at all times is important. There will be times to review your strategy, but until then, make sure you stick to your plan.

Veer from your risk –  It’s also hugely important that you don’t veer from your risk strategy. If you start taking larger or smaller positions than planned, then you’re less likely to be successful over the long term.

Day trading Vs swing trading

Day trading and swing trading are almost concepts of trading rather than individual strategies. The biggest difference between the two is the timeframe.

Swing traders, and position traders, tend to hold their positions for a couple of days and longer sometimes. While a day trader will close their positions at the end of the day.

What are the best day trading strategies?

As we’ve alluded to, day trading is a concept where you can use a number of different strategies to succeed. 

Deciding which is the best comes down to you. Each trader is different and will find that certain strategies work better for them than others. We’d recommend you test out a few using a demo account and see which ones you prefer and then adapt as you like.

What kind of strategies can you use to day trade? There are lots, we’ve highlighted a few of the most popular below:

  • Breakout trading
  • Scalping
  • Momentum trading
  • Price action
  • Reversal trading
  • Pivot points
  • Trend trading
  • Money flows
  • Day trading summary

Breakout trading

Breakout day trading is when you trade the break out of a consolidation period. This could be while the market is ranging or in a trend and breaks the opposite direction.

Either of the above mentioned would be held by an indicator (the one you use depends on your strategy). This could be a support or resistance level, a trend line, a moving average or any other indicator that allows for a break.

As a day trader, you’d be looking for these breaks on small time frames (5-15 minutes more than likely) and it doesn’t matter on the direction. You can go long or short, as long as the market gives you the correct signals.

To understand how you can trade a breakout, you can take a look at our lesson ‘What are trendlines and breakouts in trading?

Breakout trading
Screenshot from MT5

 

Scalping

Scalping is a strategy that can only be done via day trading because you’re only holding positions for very short periods of time. You’re simply looking for very small market movements, if you’re trading an FX major, you’d be looking for around 2-10 pips.

Scalping can be categorised by the following characteristics:

  • You’re looking for very small market moves, with tight stop losses
  • Trades can be open for a matter of seconds, no more than one hour
  • Strategies are often based around high impact news, so the trader can get in and out quickly
  • Other strategies include reversals at key levels

We take a look at scalping in our next lesson.

Momentum

Momentum trading is just as it sounds. You’re following the momentum of the market. If the momentum starts to slow, then you would look to exit your position, or even open a position in the opposite direction.

There are quite a few indicators on the market that allow you to measure this, a few that we like to include the RSI, MACD, and Slow Stochastic Oscillator.

As a day trader using momentum as your primary strategy, you be looking for the following:

  • Going long if the indicator does not signal overbought and is rising
    • A traditional buy signal is when the indicator moves from the oversold zone and starts rising
  • Vice versa, you’d be looking to go short if the indicator was not oversold and was falling
    • A traditional sell signal is when the indicator moves from the overbought zone and starts falling
  • If you find the indicator is either overbought or oversold (depending on your direction), you’d be looking to exit your position or entering a new
Momentum trading
Screenshot from MT5

 

Price action

A popular day trading strategy is using price action. 

You have probably heard of the term ‘price action’ but might be a bit confused about what it actually means. It’s referring to watching the price and how it moves. This can be done using:

  • Dow theory – Buy low, sell high
  • Candlestick formations – Buy bullish candlesticks patterns, sell bearish candlestick patterns
  • Chart patterns – Buy bullish chart patterns, sell bearish chart patterns
  • Moving averages – Buy above the moving average, sell below the moving average
  • Trendlines – Buy above the trendline, sell below the trendline

As a day trader, you’d be looking to use these in a shorter time frame. The 15-minute timeframe is a popular one and one we’d say is good to start with.

Reversal

Reversal trading is simply using an indicator to pick a top or a bottom or a trend and predict the reversal. 

This could be done using support and resistance or any number of indicators. Ideally, you would pinpoint a level where you expect the reversal to happen and then combine that with an indicator that says it will reverse there.

An example might be:

  • Find a zone using a resistance level
  • Execute the trade on shooting star candlestick formation at that level
Reversal trading
Screenshot from MT5

 

Pivot points

Pivot points are calculated using a formula and give you pre-determined support and resistance levels. They work because thousands of traders also use these levels.

Just like support and resistance trading, you’re looking to trade between the pivot levels highlighted by the formula. You tend to go long if the markets have opened above the pivot point and short if it opens below the pivot point.

It’s great for day trading because you can see where the market is and where the pivot point is. This will then determine the direction of your trades for that day.

If the market opens above the pivot point and ends up below, you don’t trade that market and simply go and find another market to look for a setup.

We take a look at pivot point trading in our ‘What is support & resistance in trading?’ lesson.

Screenshot from MT5

 

Trend trading

Day trend trading is a set rule where you determine the underlying trend and only take positions in that direction.

If you highlight the trend as going up, you will only take long positions and vice versa if the market is going down.

You can use short time frames, including 5 and 15-minute to enter your trade in that direction.

There are several ways you can identify the underlying trend. You can use a trend line, a moving average, dow theory, MACD, any number of indicators. You could use the same strategy to identify the underlying trend, and then drill down to a smaller time frame to use it again to help pinpoint your entry.

Understanding how to identify a trend is important, we take a closer look in our lessons ‘What are trading channels?’ and ‘What are trendlines and breakouts in trading?’.

Screenshot from MT5

 

Money flows

Another popular day trading strategy is using money flow. You can use price action for this but you can also use additional information including volume to understand the money flow.

If you were a money flow day trader, you would combine both price action and volume to base your decisions. And again, using short time frames.

Money flow example

If the market is trending up and you see a large volume of selling, this could be a signal that the market is slowing. This would help you either exit your long position or look to open a short position once the price action agreed with the signal.

Day Trading Summary

We’ve taken a look at what day trading is and some of the major trading strategies associated with day trading.

The few key takeaways about day trading are:

  • Day trading is not for everyone. It requires time and dedication. It is basically a full-time job, so you need to be ready to commit!
  • There are lots of different strategies you can use when day trading. Ultimately it comes down to you and your style, so make sure you pick the one that you like best!

In our next lesson, we look at scalping in more detail – ‘What is scalping?’.

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