Methodology

Stocks

Module 3

Day Trading

The concept of day trading is very simple, traders buy and sell the same stocks within the same day. The timeframe that traders hold a stock for varies – it could be for anything from 10 minutes to several hours. 

 

Day trading is the riskiest investment strategy and it is unsuitable for the majority of investors. This is because stocks are less efficient in the short term, which means that they are less predictable. It is common for day traders to have almost as many losing days as winning days.  As a consequence, day trading is suitable for individuals that have a very high-risk tolerance, as those with a low tolerance for risk are likely to struggle with the unpredictability of day trading and are more likely to sell their positions at the wrong times, through fear.

 

You may think that day traders are able to deliver large returns within a single day, though they tend to deliver returns that are well below 1%. For that reason, day traders usually need to manage a large amount of money to make it a full time profession, making it unsuitable for most people. For instance, if you had $50,000 in capital and made 0.1% a day, it would only be $50 a day.

 

Therefore, many finance professionals argue that day trading is not worth the reward, for the amount of risk that investors need to take on.

How day traders make money

Day traders use stock charts to make investment decisions, trying to identify patterns in the data that they can use to make a profit. This will be covered in more detail, later on in this course.

 

Nonetheless, to illustrate how day traders make money, a very simple example would be where an investor decides to invest in a stock every Friday, after noticing that the stock price of that company increased by around 1.5%, on each of the last seven Fridays. 

 

When day traders invest in a company, they are not concerned about the performance of the business. They are looking for statistical anomalies to make money from in the short term. In order to make money, day traders hope that the stock price of a company will follow a pattern that they have identified before or move in a direction that makes sense with the pattern that it has already started. 

 

However, with stocks being less efficient or predictable in the short term, day trading is not an exact science. It is common for day traders to make loses more than they make gains, with stocks moving in different directions to what they expected. Being able to get out of a stock at the right time is what makes day trading so hard and so risky.

Why day trading is important

Even though it is very risky, day trading plays a crucial role in finance as day traders provide liquidity to stock markets. This means that investors can always have someone to sell to when needed. If day traders did not exist, then it could take a lot longer for an investor to sell their stake in a particular company. This could lead to that individual missing out on other investment opportunities that they intended to use the money for.

 

Likewise, if day traders did not exist, it could take a lot longer for investors to buy stock in a particular company. If nobody is willing to sell their stock, as they are all long term investors, then it could mean that investors would have to wait for several days or months before being able to make that investment. The consequence of this is that investors would miss out on purchasing or selling a stock at a particular price. This would make it harder for investors to know exactly how much they would be able to sell their investments for, while also making investing more expensive as brokers would spend more time completing deals for their clients.

 

This obviously has negative social implications as well. For instance, if an investor needs money urgently to pay off unexpected bills, but can’t due to a lack of investors to sell to, then it could have a significant impact on their life.

 

So, despite being riskier, day trading plays an important role in the world of investing.

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