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What is Day trading? | The rules behind it



Day Trading

What is Day Trading?

Day trading aka trading, in general, is the buying and selling of various financial instruments, that include futures, options, stocks, and currencies, with the goal of making a profit from the difference between the buying price and selling price. Everyone should learn How to start Day Trading to get succeed. The Day trading differs slightly from other styles of trading in which the positions are rarely held overnight or else when the market being traded is closed.

Day trading was formerly only available to the financial companies such as banks since only they had got the access to exchange and market the data. But with the modern technology such as the Internet, even the individual traders now have direct access to the same exchanges and market the data and can make the same trades at very low cost. So with the advent of electronic trading and margin trading, now the day trading is available to the private individuals.

Day Trading-A Formal Definition:

Day trading is the speculation in securities, specifically in buying and selling the financial instruments on the same trading day. Strictly, day trading is trading only within that day, such that all positions are to be closed before the market gets close to the trading day.

Day Traders:

Traders who are participating in the day trading are called as day traders. Traders who trade in the capacity as mentioned earlier with the motive of profit are therefore named speculators. Typically, the day traders are well-educated and well-funded. They utilize high amounts of leverage and the short-term trading strategies to capitalize on small price changes in a highly liquid stocks or currencies.

However, day trading is a short term trading method. The online trader’s intention is to get a profit from the difference between the prices of these two offsetting transactions. These two trades were called as one round trip. Commonly used securities while in a Day Trading include the shares of stock, shares of ETFs, call options and put options.

Nature of Day Trading:

Traders involved in Day Trading will close out their current positions at the end of every day and then start it all over again from the next day. There are several different styles of day trading, suited to different day trader personalities. The styles range from the short-term trading such as scalping where positions are only held for only a few seconds or minutes, to longer term swing and position trading where a position may be held throughout the trading day. By contrast, the swing traders hold the securities for days and sometimes even months, and the investors sometimes hold for years. The short-term nature of day trading, however, reduces some risks because there is no chance of something happening overnight to cause some significant losses.

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The day trader’s choice of securities and the positions has to work out in a day, or it is gone. There is no tomorrow for any specific position. Meanwhile, the swing trader or the investor has the luxury of time, since it seldom takes a while for a position to run out the way it should. In the long run, markets are however efficient, and prices reflect all the information about security.  Unfortunately, it might take a few days of short runs for this efficiency to kick in.

Pattern Day Trader:

Pattern day trader is defined by the U.S. Securities and Exchange Commission (SEC), and it describes any trader who buys and sells a particular security on the same trading day (day trades). If an investor makes more than 3 Day Trades in 5 business days, then the account shall be coded as a Pattern Day Trader. Once an account is termed as a Pattern Day Trader, he/she will need to maintain assets in the account above $25,000 to day trade. If the assets fall below $25,000, no day trades will be allowed in the account.  A pattern day trader is subject to some special rules, and the main rule being that is the trader engaged in pattern day trading must hold a margin account.

Day Trading Rules

Day Trading Rules:

Rule #1. The Three E’s: Enter, Exit, Escape

You should have an entered price, an exit price, and an escape price in case of a worst-case scenario. It is the rule number one for a reason. Before you press the “Enter” key, you should primarily know when to get in, when to get out, and what must be done if the trade does not work out as expected.

Escaping from a trade, also known as using a stop price, is essential if you want to minimize the losses. Knowing when to get in or out would probably help you to lock in profits, as well as save you from potential disasters.

Rule #2. Do Your Homework

Preparation is the key factor. First and foremost, you must have an active trading methodology in place. It can often be a work in progress since the real students of the markets would always be adjusting, improving and calibrating all parts of a trading system.

Next, have a morning routine that includes devising a watch list of tradable stocks such that to monitor thoroughly with trend, support and resistance data and trade trigger signals. Keep a news feed handy for your watch list stocks and understand the reasoning for any significant gaps up or down.

Rule #3. Don’t Trade During The First 30 Min Of The Market Opening

Rule 3 is one of those rules which you can choose to ignore if you know what you are doing, but in general, it is not a good idea to trade during the initial 15-30 minutes of the market open.

The market would often be in turmoil as it is getting its footing in the first half an hour or so. It is hard to understand the charts and even more challenging or probably impossible to find things. Novice day traders should avoid this period while also looking for the reversals. If you’re looking to make quick profits, then it is best to wait a while until you can spot rewarding opportunities. Even many pros avoid the market open.

Rule #4. Use Limit Orders & Not The Market Orders

A market order just tells your broker to buy and sell at the best available price. Unfortunately, best doesn’t necessarily mean the profit. A limit order, though, lets you control the maximum price you will pay or the minimum price you will sell. You set the parameters, and that is why limit orders are often recommended.

Rule #5. Avoid Margin Account While Trading

One of the often ignored rules in day trading is that newbies should avoid trading with a margin account. In the plainest terms, a margin account is a loan that your brokerage gives you and is secured by the funds you got in your account. You could hold these funds for buying a higher value of stocks than you can if you only used your current cash.

This leverage means that both your profit and losses are amplified. So, it is great if you are winning, but awful and potentially financially devastating if you are not. Look at a couple of day trading rules for the cash accounts that could occur even if you were not trading on margin:

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The Stock Trading 3 Day Rule

All the stocks and bonds must be settled within three days. It means that if you buy a stock, you must pay for it within three days. If you sell a stock, then the brokerage has three days to transfer the money to your account. Similarly, if you have bought and paid for the stock, it must be transferred to your account within three days.

The Free Riding Rule

Free riding is defined as the purchase of a stock using unsettled funds. Remember the stock trading three-day rule that after you sell a stock, the brokerage has got three days to deliver your money. It is considered as an extension of credit. If you are caught purchasing with the unsettled funds your account would be suspended for 90 days and throughout that time you are required to fork out any cash you owe.

Running into problems with the free riding rule can be avoided by trading on a margin account, but it’s great if beginners stick to trading with their cash until they get the hang of it and were confident in their trades. Many online brokerages have featured in place to prevent violations of the free riding rule before they even come up. It is a good plan to check with yours since mistakes still can happen.

Rule #6. Have A Selling Plan

Many spend most of their time thinking about the stocks they want to buy without considering when to sell. Before you enter the market, you must need to know in prior when to exit with a profit. “Playing by ear” is not a selling policy, nor is hope. As a day trader, you will set a price target as well as a time goal.

Rule #7. Focus On Positive Risk or Reward Ratio

Ideally, you have to maintain a 3:1 positive risk or reward ratio. It means that you risk $1 for every $3 you plan to make. To assess proper risk or reward, you should be well aware of the support and resistance price levels. Trades should be entered close to the support price levels with resistance three times further away, so those stop losses are small compared to trade targets.

Rule #8. Never Go “ALL-IN”

The worst offender of the account blow-ups is going “ALL-IN” on a single trade or position. Usually, it involves maxing out the margin as well. Leverage will cut both ways, but in reality, it will reduce much worse when you are on the wrong side of a position. Diversification among the positions would help to spread the risk. Your watch list would help serve this purpose.

Remember that win percentage may be necessary, but that can all go over the window if you are reckless with the position sizing. As a general rule, the larger position sizes should be accompanied with a shorter holding period and tighter stops.

Rule #9. Avoid Tips From Unverified Sources

Most professionals in the day trading know that buying stocks based on tips from uninformed acquaintances would almost always lead to bad trades. Identifying what stocks to buy is not enough, but it is required that you also have to understand when to sell, and by then the tipster is long gone. If you can’t trust your judgment, you may want to avoid the day trading altogether. It is necessary to turn down the noise and focus on your plans. Never act out of your emotion in the stock market, or you may need to pay for it dearly.

Rule #10. Cut Your Losses

Managing the losing trades is the key to surviving as a day trader. Though you also want to let your winners run, you cannot afford to let them run for too long. It is more art than the science to get it right, but learning how to control losses is essential if you’re going to day trade. Once again, never forget the three E’s: (enter, exit, and escape).

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