Day trading means buying and selling shares multiple times in the same day.
If you’re day trading, you’re trying to take advantage of minute price moves and scoop up small wins that add up over time.
Day trading doesn’t necessarily have to involve shares, it can also be currencies or other assets.
It’s worth pointing out that “day trading” in shares is not really the same as “investing” in shares.
Investing in shares is generally when you buy a stake in a business that will hopefully build a profit over time. When you invest, you have a look at companies that have a solid business strategy, pay off debts and will ultimately increase in value over time.
When you day trade, you’re trying to buy shares at a low price and sell at a high price in a very short space of time in very liquid markets. This means there are lots of market participants who are all buying and selling shares with each other.
You kind of don’t care what the stock you’re buying is, as long as the price moves to your advantage and there are enough people interested in it (liquidity) so they can buy when you want to sell, and sell if you want to buy.
Let’s say a day trader buys $1,000 shares at 10am.
The price begins to rise as other traders buy that stock and by 10.15am the share price is up by half (50c).
Let’s say our trader sells her position at 10.15am, and she makes $500 (minus the fee she pays her online broker). In Australia, online brokerage fees vary depending on the volume of securities being traded and the broker being used. A range of online brokerage fees may be found through finder.com.au. For this example we will use the brokerage fees range between $8 - $20 per trade.
So by 10.16am she’s made between $480 - $492.
But of course there are taxes! In Australia, when a person sells securities, capital gains tax is usually charged on the profit made from the sale. This tax is applied at varying rates depending on how long the investor has held the shares and the investors' marginal tax rate.
Regardless, when it comes to day trading, we consider tax planning to be really important.
Too tiny to bother?
$480 per trade (before tax) might not seem like much, but the point of day trading is you make lots of trades within the same day with the aim of clearing a small profit per trade.
Some traders will trade three or four times per day, some will trade hundreds of times per day and across several different shares.
That way, they multiply their profits via volume.
Overtrading is when you make excessive amounts of trades. Generally this happens when people are bored or lack discipline.
Overtrading is dangerous because, remember, each trade attracts a broker fee. So you could be making thousands of tiny buys and sells, but still paying brokerage fees on all of your trades, thereby reducing your profits margins.
Rather than waste money racking up excessive fees, undertrading is when you don't enter a position when you see an opportunity pop up.
We think undertrading generally emerges when you’re too nervous to lose money or you’ve given yourself too many entry conditions.
(ie. I’ll buy the share when it hits $50, and there are at least 100,000 other investors trading the shares of that company, and the gold price is at least $1,500, and the sun is out, and Gogglebox is on tonight…).
Too many entry conditions often cause paralysis and you’ll miss opportunities to scoop up wins.
Experts say, rather than trade like a machine gun, trade like a sharpshooter with a bow and arrow.
Types of strategies
One of the most common ways to exit a winning position is by hitting a profit target.
This is as simple (and as complex!) as making sure you sell your shares when they reach a predetermined pricing level.
Here are some common strategies that help you hit a price target.
Scalping is probably the most popular. This is when you sell as soon as a trade becomes profitable.
You’ve made any amount of money on the deal? Sell.
The thinking behind this is, it’s easier to catch small moves in share prices than large ones.
So scalpers (traders who practice scalping) watch the market all day, conducting hundreds of trades, scalping as many tiny wins as they become available.
One characteristic of scalpers is they generally use larger positions so they can make the most money off the smallest movements in price.
When share prices suddenly increase some day traders like to bet that the price of the shares will fall just as quickly.
This is called fading; when you short shares (bet they will fall) after they have increased in price.
This is a high risk strategy which is based on the assumption that the shares are overbought, that early buyers in the stock are already scooping up their profits and existing buyers will be freaked out and pull their money.
Should those things happen, the share price is likely to fall.
The price target here is when buyers begin stepping in and send the price back up after a fall, you get out.
This strategy looks at the share price movement over the day. You try and buy in at the lowest point of the day and sell at the highest.
The price target you’re trying to hit is at the reversal point - when the share price changes direction.
This is where you get swept along with a tide. Momentum strategies usually trade on news releases or a strong directional trend.
Let’s say a company releases a new product or a government policy will be good for a business, a momentum trader might jump onto a share price and ride it as it moves higher.
Another momentum trader might fad the price surge.
The price target - or the signal to exit - is generally when the volume begins to decrease.
How can you limit losses?
Some traders put “stop loss orders” in place.
These are automated rules that kick in should a certain price/condition eventuate.
For example, you could put a stop-loss order at $0.50. So when a share price is falling and hits that point, the order automatically sells at that price.
If a share price is bouncing around, you might want to put a stop loss at a recent low or (if you’re short) above a recent high.
An every day trader should have mental stop losses though.
These act as a 'stop loss order' for when certain personal criteria are violated. If a trade takes an unexpected turn, you’ll immediately exit your position.
This is all about risk - and make no mistake - day trading is a risky undertaking. It also becomes more difficult as high frequency traders conduct thousands of lightning fast deals throughout the day. As an investor it’s important to think about what your edge is, what you want to achieve and how you are going to achieve it.
So if you’re going to give it a whirl, give yourself time and do some thorough homework before jumping in.