Day Trading: A Basic Overview
While you may have heard the term, you may not be familiar with the concept of day trading. Day traders attempt to capture movements in the stock market in order to make quick money. Since there is no long-term potential for rebound, and day traders will often cut their losses if a stock or other investment goes against them, day trading is considered to be very risky, though it has the potential for quick profits.
This article will provide some insight on what day trading is and how it can help to make you money if you are able to master it.
Day trading differs from investing mainly in the duration that you hold an investment for. Investors typically are willing to hold an investment for a longer period of time while a day trader is one who generally sells an investment shortly after buying it, typically within one day or so from the purchase date.
An investor is putting their capital into a company and is willing to hold on through momentary hiccups in the investment price, while a day trader has no intention of holding a position and are merely looking to capitalize on a short term movement in the stock. Both stock investors and day traders can go long or short on a stock and make money. Going long on a stock involves betting that the stock price will increase while shorting a stock is a bet that the stock will decrease.
Day traders typically look to capitalize on a swing in a stock or other investment to capitalize on a short term fluctuation in price. In order to do so effectively, they have to identify moments when the volatility or price momentum of a stock significantly. There are many different determinants that they use in order to see if a stock looks like it will have a quick surge or drop in their prices.
One factor that day traders use to identify opportunities in the market is technical analysis. Technical analysis involves the use of graphs and other visual clues that help to identify when it is likely that a stock will increase or decrease in value.
One of the most common technical analysis factors used is a regression line. A regression line tracks the history of the stock and provides an average for a specific period of time and projection of what the price of that stock will likely be in the future.
A regression line can also be easily tracked using a software program and displayed on a graph. The mean is expected to continue along this line, and any movements away from the mean are likely to revert to the regression line. As such, a day trader will look for a position that has fallen above or below the regression line and will bet that there will be a short term movement back to the regression line. The typical name for regression lines in a trader’s lingo is moving averages, and these are typically tracked for 30, 60, or 90 days. When a stock moves one standard deviation above a regression line it is indicative that they are facing resistance above, and sellers will start selling when the line is approached thereby pushing the stock back down. If the stock moves a standard deviation below the regression line, it is called a floor and it is likely that the stock will bounce back to the mean. If the stock breaks up through the resistance above it, it is extremely bullish for a stock and a day trader will often bet on a further movement upwards or vice versa.
Often, this investment bet will not be done in a complete vacuum as a day trader will keep track of the news on the stock as well and monitor any factors that can impact the industry, as well. Other technical analysis is often used in concert with regression analysis. One item that is commonly tracked is the volume of trades.
Stocks can jump a lot if they are thinly traded and there is not many traders in the market. When a significant movement occurs with a lot of volume, then it is typically considered to be indicative of a sea change.
This means that if a stock rises with a large spike of volume all the buyers available have likely entered the market already and there may not be that enough momentum to move the stock further. The same thing occurs with an increase in volume as a stock declines. Anybody who is likely to sell the stock will sell at this point, and a new bottom is created. A new bottom formed will show resistance, and it is unlikely that, in the future, the stock will drop below this figure due to news.
Day traders will use news stories to attempt to capitalize on stock movements. The difficulty in doing so is that there are many automated trading desks that capture these movements faster than an ordinary day trader. Investment houses and large banks have trading groups set up with super fast and advanced computers that can pick up tiny movements and make many quick trades to capture these price movements faster than a day trader can. As such, day traders have commonly reverted to technical analysis and other research opportunities for identifying opportunities for picking up on stock price movements shortly before they occur.
Day trading can provide a large opportunity for individuals, and there is the potential to make a lot of money in a short term if you make the right trade. However, there is also the risk of a large loss if you make a bad bet. To protect themselves, day traders often institute stop losses where a position is automatically sold if it goes against them. A stop loss helps to protect them from a more significant loss on a position otherwise. Caution is needed when day trading but so is aggressive action to capture market opportunities when they appear in the market.