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The Basics of Day Trading: A Beginner's Guide

The Basics of Day Trading: A Beginner's Guide
Updated:
June 11, 2023
By
Liam Langers

Day trading is a popular way for investors to make money by buying and selling securities within the same day.

It can be a challenging and rewarding endeavor, but it's essential to have a solid understanding of the basics before diving in.

This guide is designed to provide a comprehensive introduction to the world of day trading for beginners, including all the essential concepts, strategies, and tools necessary for success.

What is Day Trading?

Day trading is the practice of buying and selling financial instruments within the same trading day.

This means that all positions are closed before the market closes for the day.

Day traders typically use technical analysis and chart patterns to make decisions and take advantage of small price movements in the market.

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Read this review about Robinhood (Broker)

Types of Securities that Can be Traded

Several types of securities can be traded using a day trading strategy, such as stocks, options, futures, and currencies.

Each type of security has its unique characteristics and potential for profit.

Stocks

Day trading stocks involves buying and selling shares of publicly traded companies.

Stocks are the most common type of security traded by day traders.

They offer the potential for large profits but also come with a higher level of risk.

For example, a day trader may buy shares of a company like Apple (AAPL) in the morning at $150 per share, with the expectation that the stock price will rise due to a positive earnings report, and then sell those shares in the afternoon at $155 per share, realizing a $5 per share profit.

Options

Day trading options involves buying and selling options contracts, which give the holder the right, but not the obligation, to buy or sell an underlying asset at a specific price and date.

Options are a more advanced type of security, and traders must understand how they work before attempting to trade them.

For example, a day trader may buy a call option on a stock like Amazon (AMZN) at a strike price of $3,000 per share, with the expectation that the stock price will rise above $3,000, and then sell that option in the afternoon when the stock price has indeed risen to $3,050, realizing a profit of $50 per option.

Futures

Day trading futures involves buying and selling contracts to buy or sell an underlying asset at a specific price and date in the future.

Traders often use futures to speculate on the direction of commodity prices or hedge against price movements in other securities.

For example, a day trader may buy a futures contract on crude oil at $60 per barrel in the morning, with the expectation that the price of crude oil will rise due to political instability in a major oil-producing country, and then sell that contract in the afternoon at $62 per barrel, realizing a $2 per barrel profit.

Currencies

Day trading currencies, also known as forex, involves buying and selling different currencies to take advantage of price movements.

Forex is the largest financial market in the world and offers the potential for large profits, but it also comes with a high level of risk.

For example, a day trader may buy the currency of a country like Japan (JPY) in the morning at a rate of 100 JPY per 1 US dollar (USD), with the expectation that the JPY will appreciate against the USD due to positive economic data, and then sell that currency in the afternoon at a rate of 101 JPY per 1 USD, realizing a profit of 1 JPY per 1 USD.

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Read this review about Binance (Crypto Exchange)

Key Concepts of Day Trading

Day traders need to understand several key concepts to be successful.

Here are some of the essential concepts and their explanations:

Intraday Charts

Intraday charts are charts that show the price movements of a security over a single trading day.

Day traders use intraday charts to identify short-term price movements and make buy and sell decisions.

In addition, intraday charts can help identify trends, support and resistance levels, and chart patterns.

Volatility

Volatility is a measure of how much the price of a security fluctuates over time.

Day traders use volatility to identify potential buy and sell opportunities.

High volatility can create more opportunities for day traders, but it also increases the level of risk.

Time Frames

Time frames refer to the length of time that a chart covers. Day traders typically use short-term time frames, such as 1-minute, 5-minute, or 15-minute charts.

These time frames allow day traders to quickly identify short-term price movements and make buy and sell decisions.

Risk-reward Ratio

The risk-reward ratio is the relationship between a trade's potential profit and potential loss.

Day traders use the risk-reward ratio to evaluate the potential returns of a trade relative to the potential risks.

A higher risk-reward ratio generally indicates a more favorable trade.

Order Types

Order types refer to the different types of orders that can be placed in the market.

Day traders use different order types to enter and exit trades.

Some common order types include market orders, limit orders, and stop-loss orders.

Technical Indicators

Technical indicators are mathematical calculations based on a security’s price and/or volume.

Day traders use technical indicators to identify potential buy and sell opportunities. Some common indicators day traders use include moving averages, relative strength index (RSI), and Bollinger Bands.

Trade Execution

Trade execution refers to buying or selling a security in the market. Day traders use various tools and platforms to execute trades quickly and efficiently.

Trade execution is critical for day traders since they want to take advantage of short-term price movements.

Market sentiment

Market sentiment refers to the overall attitude of investors towards a particular market or security.

Day traders use market sentiment as a way to identify potential opportunities in the market.

Position Sizing

Position sizing determines the number of shares or contracts to buy or sell based on the amount of capital you have available.

This helps manage risk by ensuring that potential losses are limited to a small percentage of your total capital.

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Read this review about SpeedTrader (Broker)

Technical Analysis

Technical analysis studies historical price movements and chart patterns to identify potential buy and sell opportunities.

Day traders use technical analysis to make decisions and take advantage of small price movements in the market.

Chart Patterns

One of the most commonly used methods of technical analysis is the study of chart patterns.

Chart patterns are formations that appear on a security’s price chart and can indicate the direction of future price movements.

Some common chart patterns include head and shoulders, double tops and bottoms, and trendlines.

For example, a day trader who notices a head and shoulders pattern forming on a stock’s price chart may interpret this as a bearish signal and choose to sell the stock.

Indicators

Another technical analysis method uses indicators, which are mathematical calculations based on a security’s price and/or volume.

Some common indicators day traders use include moving averages, relative strength index (RSI), and Bollinger Bands.

For example, a day trader who notices that the RSI of a stock is approaching overbought levels may interpret this as a bearish signal and choose to sell the stock.

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Read this review about RoboForex (Broker)

Fundamental Analysis

Fundamental analysis studies a company's financial and economic fundamentals to identify potential buy and sell opportunities.

Day traders use fundamental analysis to make decisions and take advantage of price movements in the market.

Earnings Reports

A company's earnings reports are one of the most important fundamental factors to consider when analyzing a stock.

Earnings reports show a company's profitability and financial health, which can significantly impact the stock's price.

For example, a day trader who notices that a company's earnings report has exceeded expectations may interpret this as a bullish signal and choose to buy the stock.

Economic Indicators

Economic indicators such as Gross Domestic Product (GDP) and employment data can also be used in fundamental analysis.

These indicators provide a snapshot of a country's economic health and can impact the performance of stocks and other securities.

For example, a day trader who notices that a country's GDP is growing faster than expected may interpret this as a bullish signal for the stock market and choose to buy stocks.

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Read this review about Forex.com (Broker)

Choosing a Trading Strategy

There are several different types of day trading strategies, each with its unique approach.

Choosing a strategy that best suits your goals and risk tolerance is essential.

Here are some popular day trading strategies:

Scalping

Scalping is a strategy that involves making many trades in a short time, typically holding each position for only a few minutes or seconds.

This strategy is best suited for traders who can tolerate a high level of risk and have the ability to make quick decisions.

Momentum Trading

Momentum trading is a strategy that involves buying securities that have recently had strong price movements and selling them after a moderate price increase.

This strategy is best suited for traders who can identify market trends and have a moderate level of risk tolerance.

Breakout Trading

Breakout trading is a strategy that involves buying or selling a security when it breaks through a significant level of support or resistance.

This strategy best suits traders who can identify key support and resistance levels and have moderate risk tolerance.

Position Trading

Position trading is a strategy that involves holding positions for an extended period, typically several days or weeks.

This strategy is best suited for traders with a long-term investment horizon and a low level of risk tolerance.

Swing Trading

Swing trading is a strategy that involves holding positions for a few days to several weeks, looking to take advantage of medium-term price movements.

This strategy is best suited for traders who have a moderate investment horizon and a moderate level of risk tolerance.

Arbitrage Trading

Arbitrage trading is a strategy that involves taking advantage of price differences between different markets or exchanges.

This strategy is best suited for traders with a low level of risk tolerance and can identify and act on price discrepancies quickly.

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Read this review about IQ Option (Broker)

Risk Management

Risk management is an essential part of day trading.

Therefore, it’s important to have a plan to manage risk, such as diversification, stop-loss orders, and position sizing.

Diversification

Diversification is spreading your investments across different securities to reduce the risk of losing all your money in one trade.

For example, a day trader may choose to invest in a portfolio of stocks from different sectors, such as technology, healthcare, and finance, to diversify their risk.

Stop-Loss Orders

A stop-loss order is an order to sell a security when it reaches a specific price automatically.

This helps to limit potential losses on a trade.

For example, a day trader may set a stop-loss order at 5% below the purchase price of a stock so that if the stock's price drops 5%, the stock will be automatically sold, minimizing the losses.

Position Sizing

Position sizing determines the number of shares or contracts to buy or sell based on the amount of capital you have available.

This helps manage risk by ensuring that potential losses are limited to a small percentage of your total capital.

For example, a day trader may choose to invest no more than 2% of their total capital in any trade.

This way, they are not risking too much on one trade.

Legal and Regulatory Environment

Day traders need to understand the legal and regulatory environment of day trading and how to comply with regulations such as the pattern day trader rule.

The pattern day trader rule is a regulation set by the Securities and Exchange Commission (SEC) that requires traders who make more than four day trades in a five business day period to have at least $25,000 in their trading account.

This ensures that traders have enough capital to withstand potential losses.

Resources and Tips

There are many resources and tips available for those looking to learn more about day trading and how to use it as a tool for managing risk and generating income.

These include online educational resources, such as webinars, online courses, trading simulators, and tips from experienced traders.

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Read this review about FxPro (Broker)

Key Takeaways

  • Day trading is buying and selling securities within the same day.
  • Different types of securities can be traded using a day trading strategy, such as stocks, options, futures, and currencies.
  • It's essential to understand key concepts of day trading, such as intraday charts, volatility, and time frames.
  • Technical analysis and fundamental analysis are important for making informed trading decisions.
  • It's vital to choose a trading strategy that suits your goals and risk tolerance.
  • Risk management is an essential part of day trading, and it's important to have a plan to manage risk.
  • Day traders must understand the legal and regulatory environment and comply with regulations such as the pattern day trader rule.
  • There are many resources and tips available for those who want to learn more about day trading.

Conclusion

Day trading can be a challenging but rewarding endeavor, with the potential to generate income and manage risk.

It's essential to have a good understanding of the basics, including different types of securities and key concepts, and a risk management plan in place.

Additionally, it is crucial to be aware of the legal and regulatory environment and comply with regulations.

With the proper knowledge and tools, day trading can be valuable for managing risk and generating income.