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Day trading is an extremely risky investment practice that requires a lot of research and investing experience. As a result, day trading is not something the casual investor should approach, as the amount of stress and risk of loss is far greater than other approaches to investing.
Here's what to know about how day trading works, why it can be risky and who should consider it.
How Day Trading Works
Day trading involves buying and selling stocks and other investment securities within the same day, generally to try to take advantage of short-term price movements. Day traders often trade on margin to increase their exposure in the market.
Day traders use what's called technical analysis to make decisions, instead of looking at the financial health of a company. For instance, they'll analyze price and volume data to spot trends in pricing.
Day traders typically never hold onto a position overnight, choosing to sell before the market closes each day, win or lose. They may work on their own or for an investment firm that makes investments on behalf of others.
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Day Trader Requirements
You're considered a pattern day trader if you make four or more day trades within five business days, according to the Financial Industry Regulatory Authority (FINRA).
As a day trader, there are some FINRA requirements you'll need to meet if you want to continue making trades:
- You'll need at least $25,000 of equity in your margin account on any day that you actively trade.
- You cannot trade in excess of your day trading buying power. This number is typically up to four times the "maintenance margin excess"—the amount by which the equity in your margin account exceeds the required margin as of the close of business of the prior day.
How Much Money Can You Make?
The amount you can make with day trading will depend on a variety of factors, including:
- How much you have invested.
- The types of securities you're investing in.
- Your experience with technical analysis.
- Your investment strategy and risk tolerance.
- Your ability to remove emotion from the process.
If you're looking into day trading as a career, remember that you could actually wind up losing money. In fact, as much as 95% of day traders end up losing money, depending on which study you read. As a result, it's generally not a good idea to try day trading on your own unless you have years of experience.
You could, however, opt to gain experience by day trading for an investment firm. On average, day traders earn an annual pay of $108,156, according to Glassdoor.
How to Get Started With Day Trading
First things first, you'll need to meet the $25,000 minimum equity requirement to be able to day trade. Keep in mind, though, that that's the minimum—you'll need much more capital on top of that to be able to make a significant profit.
Also, keep in mind that to become a successful day trader, you'll need to maintain focus throughout the day, which means it's almost certainly incompatible with having another full-time job. For that reason, you'll need to have enough savings or income from other sources to sustain yourself while you get started.
You can day trade through an online broker or other trading platform. Take your time to compare different options to find the one that's best suited to your strategy and offers the tools and resources you need to succeed.
What Are the Risks of Day Trading?
The allure of the stock market is strong for many investors, but because of the many risks associated with day trading, most should stick with a more traditional buy-and-hold strategy instead. Here are some of the pitfalls to watch out for:
- You may be subject to a margin call: If you exceed your buying power limitation, your broker will issue a margin call that requires you to deposit enough funds to meet the firm's requirement. If you don't, your account may be subject to trading restrictions.
- You'll face higher risks: Heightened risk almost always accompanies the potential for greater returns. Stocks can be very volatile in a market day, and it can be difficult to keep track well enough to take advantage of price swings. If a stock's price drops when you expected it to rise, you could experience a quick and potentially significant loss. And because day traders typically borrow on margin to trade, losses can be magnified.
- Expenses can add up: Day traders tend to spend a lot on trading commissions, tools, training and other expenses necessary for the job. This means that you need to earn a certain return just to cover your entry costs. If you can't, these expenses just add to your losses.
- The stress can be immense: Day trading often involves watching price trends for dozens of stocks, which can be stressful. If you can't manage the stress, it could be easy to make mistakes. That's particularly true if you struggle to leave emotion out of your investment decisions.
What Are Less Risky Ways to Invest?
There are plenty of approaches you can take to investing your money that involve less risk than day trading. Here are some investment strategies to consider:
- Buy and hold: The buy-and-hold strategy involves investing in stocks and other investment securities for the long haul. This typically involves researching companies to invest in and choosing them based on factors that are important to you, such as dividend yield, price stability, growth potential and value.
- Dollar-cost averaging: Dollar-cost averaging (DCA) involves investing the same amount of money every month in the stocks, funds and other securities that you own. The DCA approach can help you avoid making emotional decisions and reduce the cost basis of your positions over time.
- Exchange-traded funds and mutual funds: Purchasing exchange-traded funds (ETFs) and mutual funds can be an easy way to diversify your portfolio. These funds typically include dozens or even hundreds of stocks, bonds and other securities, which helps to eliminate some of the risks associated with individual securities. You can even buy ETFs and mutual funds that track specific indexes, such as the S&P 500.
- Focus on retirement: While the idea of short-term gains is attractive, most investors should start by focusing on their retirement fund because long-term investors are able to weather short-term volatility. If your employer offers a 401(k) plan and matches some of your contributions, save enough to maximize that employer match. You may also consider having a traditional or Roth IRA on the side, which can give you some more control over how your money is invested.
- Use a robo-advisor: Having someone else manage your investments for you can be expensive. But if you do want some help, consider a robo-advisor. These investment products use algorithms to choose how to invest your money based on your risk tolerance and other factors. While you won't have complete control over your investments, using a robo-advisor can help you maintain a diversified portfolio based on your goals.
Take Your Time to Establish Your Investment Strategy
Developing an investment strategy can take a lot of time and research, and it's possible that your strategy will change over time. Don't be afraid to wait to invest as you determine the best path forward. You may even consider enlisting the help of a financial advisor who can provide you with objective, expert advice.
Whatever you do, be sure to research different approaches to investing before engaging. Internet trends can be tempting, but they almost never work out for the majority of investors.