What Is Day Trading and How Does It Work

What Is Day Trading and How Does It Work?

Day trading is the buying and selling (or selling and buying) of the same security during the same trading session to take small, frequent profits. Some day traders are discretionary traders, meaning they decide when to open and close trades based on current market conditions and intuition. Others are system traders who follow a predetermined set of rules to place trades. System traders often automate their strategies, allowing their computers to scan for, enter, manage, and close trades.

Unlike long-term investors who typically try to buy low and sell high, many day traders are just as likely to sell short. This means they sell high and buy low to profit from falling prices. While buy-and-hold investors tend to ride out market volatility by holding positions for the long term, day traders attempt to profit from it on a daily basis, going into and out of positions to exploit small price fluctuations. Because day traders rely on intraday price fluctuations and fast order execution, their chosen instruments typically trade under high volume (with good liquidity) and with substantial volatility.

What Are the Risks of Day Trading?

Day trading can be lucrative, but as with any type of investing, there are risks. One of the most significant risks for retail day traders is that they are competing against a stacked field of professionals who have the resources (e.g., speed, trading capital, technology, and software) to succeed. Without a level playing field, it can be difficult for retail traders to profit on a regular basis.

Another notable risk is that day traders often use leverage to enter positions, which means they can lose more than they risk on any given trade. This can be especially devastating with short trades—where the trader sells "high" in the hopes of buying to cover "low" at a profit—which have virtually unlimited risk since prices can continue to climb indefinitely. One more significant risk is being undercapitalized. Traders who don't have enough trading capital can burn through their accounts quickly, putting an early end to their day trading careers. What's more, traders who fund their accounts with anything but risk capital stand to lose more than their trading accounts.

How Do You Start Day Trading?

If you decide that day trading is right for you, start by opening an account with a broker that offers paper trading (aka simulated or "sim" trading) so that you can practice trading before risking real money. Interactive Brokers, TradeStation, and Webull all offer simulated trading environments to help you hone your skills and try out new ideas. Be sure to practice your order-entry skills to minimize the risk of making costly errors when placing trades—for example, hitting the buy button when you meant to sell. Also, take the time to learn the platform's features so you can take full advantage of them when real trading starts.

While you're practicing and learning how to use the platform, you can develop and fine-tune your trading plan. Before risking real money, you should have a written trading plan that you can review before every trading session. Be sure to evaluate your trades at the end of every session so you can keep track of what's working, and what's not. Keep in mind that markets change over time. A day trading plan that works today may not be as profitable next year or even next month, so you have to continually evaluate and adapt your plan.

When you begin trading with real money, start small. Once you have more experience (and a proven track record), you can trade larger positions.