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What is Day Trading?

Investing Basics: Day Trading

understanding-daytrading

You may have heard the words “Day Trading” in passing, without truly understanding the intricate details that surrounding it. Many influencers may make it appear to be a get rich quick scheme, however, it is not for the faint hearted. Day trading requires discipline and the ability to make quick, informed decisions under pressure.

Day Trading

Day Trading is a high-intensity style of trading where positions are opened and closed within the same day, requiring quick thinking and discipline. Officially defined by FINRA as “a trading strategy where an individual buys and sells (or sells and buys) the same security in a margin account on the same day “ Day Trading is an extremely popular strategy as you don’t take on the risk of holding positions overnight.

Margin Accounts

To qualify as a day trader, you must first operate using a margin account. A margin account is a type of brokerage account that allows you to borrow funds from your broker, primarily to avoid the standard settlement period. This means you can buy and sell securities on the same day without having to wait for trades to settle. This settlement period was created by the SEC to ensure that trades are properly processed.

Alternatively, margin accounts also provide additional buying power. For example, if you have $2000 in your account, you can you can use your margin to borrow funds from your broker. Depending on your broker’s margin requirements, you could borrow up to an additional $2000 for purchasing even more shares. It should also be noted that, although you can increase your potential returns, the loses are equally amplified. Never put up more than you are willing to lose.

Pattern Day Trade Rules

The Pattern Day Trade Rule was created by the Financial Industry Regulatory Authority (FINRA). It was established to protect investors by requiring that traders who execute four or more day trades within five business days in a margin account must maintain a minimum account balance of $25,000. If you have a balance below the threshold of $25,000, you will be limited to a total of 3 trades every 5 business days. This is extremely important to understand as a day trader and run the risk of getting restricted with your trading.

If you happen to exceed these limitations set, you will be issued a margin-call. A margin call is demand from your broker to deposit additional funds or securities into your account to meet the minimum margin requirements. If you fail to do so, you run the risk of being able to trade your cash balance for 90 days. Each time you close out a trade, the funds will and can take days to settle.

Risk and Reward

Like anything, day trading comes with a hefty risk especially if you you over-leverage yourself. You always want to make sure you have a decent risk to reward ratio. Risk to reward ratios are used as a way to evaluate the potential profit of a trade relative to its potential loss. A good risk-to-reward ratio can act as a safety net to ensure you’re able to come out on top of any loses. Common risk-to-reward ratios would be 1:2 or 1:3, meaning that for every dollar you’re willing to risk, you aim to make two or three dollars in profit. More information on Finra’s risk disclosure can be found here.

Frequently Asked Questions

Frequently Asked Questions: Day Trading

Day trading is a trading strategy where positions are opened and closed within the same trading day.

Day trading can be difficult due to the fast-paced nature and the need for quick decision-making. It requires a basis of a trading strategy to be successful.

The best time to buy depends on your strategy, but many traders prefer the first hour of the market opening (9:30 AM - 10:30 AM EST), when volatility and volume are highest.

The U.S. stock market opens at 9:30 AM EST and closes at 4:00 PM EST.

PDT stands for Pattern Day Trader. It refers to traders who make more than three-day trades within five business days. These traders must maintain a minimum balance of $25,000 in their margin account.

You can open a margin account with most brokers by applying online. You'll need to meet the broker’s requirements, which typically include agreeing to a margin agreement and maintaining a certain minimum balance.

Yes, day trading is risky due to the volatility of the market and the potential to lose large sums of money in a short period.

To start day trading, you should first educate yourself on the market and different strategies. Then, open a brokerage account, preferably with a margin account, and start with small trades while practicing risk management.

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