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What is Day Trading? (And The Main Trading Styles)
Published: 01/27/2020

Blue sky and some cloud

There are many trading styles available to trade the global financial markets. From very short-term scalping to long-term position trading where trades are sometimes held for months or years, trading suits almost all personality types.

One trading style is especially popular among retail traders and online trading – it’s day trading. As its name suggests, day trading refers to a trading style where trades are held over the day and are usually closed by the end of the trading day, giving the day trader an immediate insight into his or her trading performance during the day. 

Here, we’ll dig deeper into the exciting world of day trading and compare its pros and cons with other trading styles.

 

What Are the Main Trading Styles?

There are four main trading styles and many other which are derived from the main four ones. Major trading styles include scalping, day trading, swing trading, and position trading.

#1 Scalping: Scalping is the most short-term style out of the four major trading styles. A scalper (someone who’s following a scalping strategy) trades dozens of trades per day, aiming for small profits on each trade. 

It’s not unusual for scalpers to trade on timeframes as short as the 1-minute of 5-minute ones, and to hold their trades for seconds in an attempt to squeeze a few pips out of a rally. 

Given the very large number of trades taken by a scalper during a day, trading costs can have a significant impact on a scalper’s trading performance.

 

#2 Day Trading: Day trading, contrary to swing trading or long-term investing, requires the trader to make several trading decisions every day with the aim of making several profitable trades that potentially add up to much higher gains than what swing trading or long-term investing potentially could. 

It can be a very rewarding and exciting way to approach the market. However, just like scalping, it has its negatives and not everybody has the time, psychological discipline and endurance to stick to it.

Day traders usually base their trades on the 30-minutes, 1-hour, and 4-hour charts. They scan the market for trade setups early in the morning, open their trades, manage them throughout the day and aim to close them with a profit by the end of the trading day. 

Unlike some pundits may suggest, day trading is a full-time job that requires discipline and the ability to control emotions in times of high market volatility

 

#3 Swing trading: In terms of the trading time horizon, swing trading is a longer-term trading style compared to scalping and day trading, but one still has a shorter holding period than position trading. 

Swing traders usually trade on intermediate timeframes, such as the 1-hour, 4-hour, and occasionally daily ones, and hold their trades from a few days to a few weeks. They aim to profit on “swings” in the market, i.e. persistent up-moves and down-moves triggered by changes in macro-economics or initiated by important technical levels. 

Trading costs are usually not a major consideration for swing traders, given their relatively small number of trades and attractive reward-to-risk ratios.

 

#4 Position trading: The longest-term trading style among the top four ones is position trading. Position traders need to have tons of patience and discipline while trading, as they can wait for weeks or months for a trading setup to confirm. 

Most position trades are based on fundamental analysis, given the importance of fundamentals and changes in the macro-economic environment in the long run. Technical analysis is usually used to fine-tune entry and exit points and not to scan the market for trading opportunities. 

Given their long-term view of the markets, position traders need to be well-capitalised to withstand negative price fluctuations.

 

FINRA: What is “Day Trading” and a “Pattern Day Trader”?

The US Financial Industry Regulatory Authority, FINRA, describes typical day traders as traders who “… rapidly buy and sell stocks throughout the day in the hope that their stocks will continue climbing or falling in value for the seconds to minutes they own the stock, allowing them to lock in quick profits”

FINRA also adds that “… day trading is extremely risky and can result in substantial financial losses in a very short period of time.”

Additionally, FINRA has defined rules that classify a person as a day trader, or as they call it “Pattern Day Trader”, as a person who “… executes four or more “day trades” within five business days, provided that the number of day trades represents more than six percent of the customer’s total trades in the margin account for that same five business day period.”

Summing up, the definition is quite simple – a day trader is a person who trades with quite frequently with the aim of taking a short-term profit out of the market before the trading session closes.

 

Day Trading Strategies

Day traders employ a variety of trading strategies, ranging from pure technical ones to fundamental analysis and news trading

Nevertheless, three trading strategies stand out from the crowd, also called the three major day trading strategies: trend-following, breakout trading, and counter-trend trading.

 

Trend-following

A trend-following day trading strategy aims to catch trades in the direction of the underlying trend. When the trend is up, a trend-following strategy sends a “buy” signal, and when the trend is down, the strategy yells “sell.” 

Trend-following strategies are usually easy to implement and are recommended for beginner traders given their easy risk management.

 

Breakout trading

Breakout strategies are based on breakouts out of important technical levels and chart patterns. Markets tend to become quite volatile and move on a large momentum immediately after a breakout. 

The reason for this lies behind limit orders – many market participants watch for breakouts and place their pending orders above or below those levels that accelerate the breakout move. 

Common technical levels to trade breakouts include support and resistance levels, trendlines, channels, rectangle and triangle patterns, and head and shoulders patterns, to name a few.

 

Counter-trend trading

Last but not least, counter-trend trading refers to taking trades in the opposite direction of the underlying trend. Counter-trend traders sell during uptrends and buy during downtrends. While this might sound counterintuitive at first, bear in mind that markets tend to move to their mean over the short-term (mean-reverting), and this strategy aims to take advantage of this market phenomenon. 

Counter-trend traders usually do so by selling at important resistance levels and buying at important support levels. Nevertheless, counter-trend trading is somewhat riskier than the other mentioned strategies and should be used only by more experienced traders.

 

Expert tip
Markets tend to revert to their mean-value in the short-term, but to trade in the direction of the underlying trend (crowd-following) in the medium and long run.

 

Advantages of Day Trading

Independence: Day trading allows to be independent and to create your own work schedule – you are your own boss. There are plenty of opportunities the next day across the broad spectrum of markets and taking a day off is nothing unusual.

No overnight risk: Any position is usually closed before the trading session is done, therefore, allowing for no additional risk arising from sudden market news after the trading session has completed or the market opened with a gap. 

This allows a day trader to have time during which he is not exposed to the market and no attention is required – similar to a regular day job, after which you can spend your free time charging your batteries for the next trading day.

Tight stops: Day traders can use much tighter stops that reduce the maximum potential loss in a single trade. This means that a larger position size with more leverage can be traded in order to amplify the potential return. 

Gaining experience: Trading more often means that much more experience in the markets can be gained in a shorter timeframe as the trader sees various price action patterns develop much faster and can later apply this knowledge in longer-term trading.

Excitement: Day trading can be much more exciting than longer-term trading styles as there is always something going on in the markets. 

 

Downsides of Day Trading Compared to Other Trading Styles

Required attention: Day trading requires to spend a lot of time in front of screens and usually requires a full commitment to it. Managing a regular day job and day trading can be quite difficult, as opposed to swing traders who need to dedicate less screen-time in order to find new trade setups, check up on existing ones, and spend the rest of their day working a day job.

Stress: Day traders have to be focused every day for a long period of time. Therefore, good psychological and physiological endurance is crucial as the increased stress can wear you down as opposed to longer-term trading styles. Staying healthy, active, and paying attention to diet is quite important for day traders.

Calm hours and low liquidity: Price volatility and liquidity are important for a day trader to make returns and enter/exit the market as fast and efficiently as possible. During calm and illiquid market hours, day traders might not find enough trading opportunities. Plus, the risk of low liquidity can reduce the potential profit, since entering/exiting a slow market can lead to slippage in the price. This, however, does not impact longer-term traders to a large extent.

The use of leverage: Since day traders usually use high leverage, losses can quickly add up if several positions go against the desired outcome in a short amount of time. Those can be stressful times for day traders who have the habit to follow their open trades all day long.

Trading costs: Frequent trading increases the total amount of commissions paid and can eat into realised profits, especially when markets are calm and bid-ask spreads widen

 

Read:

The Beginners Guide to Brokers Platforms

The Beginners Guide to Choosing a Broker

Secrets Brokers Hate You to Know (Revealed!)

 

Well, Should You Become a Day Trader?

The answer depends on your own preferences and lifestyle. If you want to commit to trading full-time and can stay focused for long periods of time without difficulty, day trading can be an attractive trading style for you

However, if you have a full-time job or other responsibilities and don’t want to or simply can’t spend hours every day checking the market, you would be better off with swing or position trading. Nevertheless, to fully understand whether a particular trading style suits your needs, you need to give it a try for a few weeks or months.

One could start as a swing trader and add some day trades for a more diversified approach. After a few profitable months, try to gradually shift to a full-time day trading style as you become more confident with the price action of the market and your own decision-making ability.

Alternatively, a day trader can also transition into a medium-term swing trader if the lifestyle of a day trader no longer seems appealing and other commitments keeps him away from spending the time required to monitor the markets for short-term price action.

Last but not least, if a combo of trading styles seem appealing to you, why not combine them and diversify your trading approach?

There are many traders who successfully combine different trading styles.

 

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