Author, Serial Entrepreneur, Real Estate Investor, Stock Trader & cofounder of The Ligon Group.
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Day trading has become a popular method for investing in the financial markets. Intraday trading differs from the typical form of stock investing where an investor holds a security for an extended period of time. When an investor day trades, they typically open and close their positions rapidly within the same day.
Defining Day Trading
A day trade is a term describing the buying and selling of the same security intraday. These securities or financial assets include stocks, currencies, bonds, commodities and exchange traded funds (ETFs). Day trading is one of the most common forms of stock trading—swing trading and long-term investments being other common forms, differing by the duration the trader holds their position in the security. Anyone with capital can invest in the stock market; however, in order to day trade stocks, the investor is required to have at least $25,000 in capital to meet the pattern day trading rule (PDT) requirements.
The Pattern Day Trading Rule
In order to make four or more trades within a five business day period, an investor must meet the United States Securities and Exchange Commission’s (SEC) rule for pattern day trading.
The PDT rule is a designation created by the Financial Industry Regulatory Authority (FINRA) specifically for intraday trading. As a day trader of stocks, investors must maintain a minimum equity of $25,000 in their margin account. This can be a mixture of cash and eligible securities. If the equity in the account falls below $25,000, the trader will be prohibited from any further trades until the minimum balance is restored.
Understanding What Stocks To Trade
Once the minimum trading requirements are met, it’s time to understand what stocks to trade. Many intraday traders look to penny stocks for their day trades. A penny stock is defined by any security trading under $5.00 per share. Penny stocks, formally known as microcap stocks, are stocks with a small market capitalization of less than $250 million or $300 million. I’ve found the main draw for penny stocks is volatility in the price action. This means that these stocks have the ability to make large swings in value creating the opportunity for high percentage gains and losses. They are much riskier investments than their blue chip counterparts, but for day traders, they can be very profitable.
Because penny stocks can make such massive swings, traders can enter and exit trades within hours or even minutes and generate profits quickly. These stocks are also very risky for the same reasons. Since they move with such volatility, an inexperienced trader can lose a lot of money in a very short period of time. This brings us to another very important part of day trading.
Analyzing Trades
Once an investor has the funds to trade and knows what stocks to research, it’s time to learn how to enter and exit intraday trades. Day traders use numerous tools to analyze their trades. Two of the most common are technical analysis and price action. Technical analysis refers to the process of using indicators, like relative strength index (RSI), MACD and moving averages (MA) to analyze assets. Price action refers to the analyzing of price movements viewed on charts to determine trends and patterns. Both are powerful tools that can assist traders in making quick and informed decisions in their trading. It is imperative that investors become proficient in analyzing trades before attempting to day trade. Investors can do this by paper trading until they feel extremely comfortable and confident in their trading abilities.
Paper Trading
Paper trading is simulated trading that allows a day trader to practice in analyzing trades and placing trades without using real money. Many brokerages provide a full working copy of their trading platforms in a paper trading format for their investors. Paper trading simulators look and act just like a real trading platform. It is highly recommended that everyone paper trade before placing any real trades in the stock market.
Understanding The Risks
Day trading can be a very risky way to invest in the stock market, but it can also be a lucrative way to make money. Be aware that even the most experienced traders will lose money from time to time. Many professional money managers and financial advisors argue that the rewards of day trading do not justify the risks. However, successful day traders insist that it’s a highly profitable endeavor. Either way, there’s no doubt that it is inherently risky and it requires considerable skills to day trade successfully. Every newcomer to trading needs to ensure that they take the time to learn technical analysis, price action and fully understand the market before they place their first trade.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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