Day trading is a short-term trading strategy that involves buying and selling securities within one day. A day trader may hold onto a position for seconds, minutes, or hours, but definitely closes the position before the end of the trading day. Day trading is usually associated with stock and currency speculation, but any financial instrument can be day traded. In this tutorial, we will explore using day trading techniques for buying and selling options.
Before delving deeper into day trading options, it is important to understand the basics of day trading.
What Is a Day Trader?
A day traders buys financial instruments such as stocks, stock options, commodities, currencies, or futures and sells them before the close of the trading day. Day traders can work for financial institutions, such as banks or investment funds, or they can work for themselves by investing their own money. Day traders may hold a stock for just seconds or minutes. They also frequently buy and sell the same stock again and again within a single trading day. One of the key strategies in day trading is to capitalize on small price movements by investing large sums of capital in highly mobile stocks or indexes. With this strategy, a small percentage gain can result in a sizeable profit. However, it also follows that small dips can result in sizeable losses.
What Is a Pattern Day Trader?
According to the Financial Industry Regulatory Authority (FINRA), a pattern day trader buys and sells the same security four or more times over a five-day period. To be considered a pattern day trader, same-day trades should make up at least 6 percent of trading activity for the period. The U.S. Securities and Exchange Commission (SEC) subjects pattern day traders to greater regulations than regular traders. The SEC requires that pattern day traders maintain a minimum of $25,000 in their brokerage account. If at any time the balance falls below $25,000, the trader can no longer day trade. There are also complex margin account requirements. According to the FINRA, “The rules permit a pattern day trader to trade up to four times the maintenance margin excess in the account as of the close of business of the previous day. If a pattern day trader exceeds the day-trading buying power limitation, the firm will issue a day-trading margin call to the pattern day trader. The pattern day trader will then have, at most, five business days to deposit funds to meet this day-trading margin call. Until the margin call is met, the day-trading account will be restricted to day-trading buying power of only two times maintenance margin excess based on the customer's daily total trading commitment. If the day-trading margin call is not met by the fifth business day, the account will be further restricted to trading only on a cash available basis for 90 days or until the call is met.”
What is Intra-Day Scalp Trading?
This is perhaps the ultimate form of day trading. Traders using this technique buy and sell most securities within minutes, or even seconds. Intra-day scalp traders face higher-than-average risk, but also have the possibility of higher-than-average return on investment. Most traders involved in intra-day scalp trading base their trades on the technical analysis of indicators such as moving averages, moving average convergence divergence (MACD), Fibonacci sequences, momentum oscillators, and the like.
Styles of Day Trading
The majority of day traders tend to choose a single style of trading and follow that consistently. Day trading can be conducted using trend trades, countertrend trades, and range-bound trades. Trend trades are made following a trend, meaning buying a commodity that is on an upward price swing. Countertrend trading is the opposite—it involves buying a commodity that is on a downward price movement, or selling one that is still moving upward. Range-bound trades are simply trades on commodities that are reliably fluctuating in a channel—in other words, between an upper and lower price point. Range-bound trades are common in a sideways-moving market.
Day traders can vary according to the frequency at which they place trades. Some traders are like a tiger stalking its prey, holding a position and waiting for the perfect moment to pounce on and execute. Others take a more volume-based approach, trading constantly throughout the day according to pre-set parameters.
Introduction - Day Trading and Options
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