Day trading is the practice of buying and selling stocks or other equities within the same day or trading period, usually in large quantities of cheaper stock in order to extract sizable profits from small changes in the market. This is in contrast to another stock market strategy, which is to buy a smaller amount of more expensive stock and hold that position for a long time, trusting in the general upward trajectory of investments in the market to generate a profit on those equities.
Day Trader Average Return
Day trading can look like an attractive way to make money, but it comes with a lot of risks and necessary starting conditions. Most infamously, the general failure rate for day traders is around 95 percent, according to a number of scientific papers (such as this one from experts at UC Berkeley) and as explained by statistics compiled by the team at Vantage Point Trading.
Generally speaking, only about 4.5 percent of day traders are successful, meaning they generate significant profit. If success is defined simply as not losing money, the success rate only climbs to around 6 percent. Other sources put the success rate even lower, at 1 percent, especially for men.
Moreover, while it may seem at first that day trading doesn't require anything to get started besides a little initial capital, the resources needed to day trade successfully are significant. For example, the Financial Industry Regulatory Authority (FINRA) explains it requires pattern day traders to maintain an equity of $25,000 in their accounts in order to have access to the market.
Drawbacks to Day Trading
A day trader would then need sufficient capital on top of that for actual investing, and most recommendations pin that at, at least, $10,000 and preferably more like $30,000, for a total starting capital of $55,000. Day traders also typically need sufficient acquaintance with mathematics and analysis or familiarity with and access to software that can do the analysis for them.
Finally, the odds of beating the market are just not good. A frequently quoted day trader average return rate is 10 percent, but recall that the failure rate is about 95 percent. Moreover, as NYU’s 93 years of stock market return data illustrates, the average rate of return for the stock market historically has been 9.8 percent.
That means that a strategy of long-term holding is very likely to match a strategy of active day trading. As both Forbes and Vantage Point Trading explain, day trading is essentially a system of betting, and by nature all betting systems require that most people fail at them.
Types of Trading Strategies
For those day traders who do manage not to lose money, the key is finding a successful strategy and sticking to it. However, "success" is defined very conservatively here; a day trader can expect to lose 40 to 50 percent of the time even with a solid strategy. Many amateur traders, when faced with this loss rate, think they are doing something wrong and keep switching strategies. This plays a key role in the failure of many who attempt to day trade.
When choosing a day trading strategy, it's important to consider your target markets, your resources (including capital, software, time and access to information), and your temperament and risk comfort level. Broad day-trading strategies can be broken down as done by Investor's Business Daily.
First, swing trading is a high-risk/high-reward strategy centered around identifying stocks with short-term price momentum. This is done using a combination of technical analysis, familiarity with price patterns and trends, and understanding a stock's fundamental value.
More Day-Trading Strategies
Mergers and acquisitions trading focuses on identifying companies that are in the process of a merger and acquisition and taking advantage of the stock fluctuations this causes. This strategy carries moderate risk and has the potential for significant gains, but it can be difficult to execute.
Trading based on news involves reacting to current events sufficiently ahead of the rest of the market to generate a profit. While this approach doesn't rely on technical analysis nearly as much as other approaches, it can be very difficult to obtain and judge timely information. This strategy carries moderate risks and rewards. Abritrage trading involves comparing price differences in securities that should be trading similarly. This strategy is low-risk and can garner moderate rewards.
Executing a lot of day-trading strategies involves significant amounts of analysis, access to information, risk and just plain luck. For those interested in day trading, understanding the strategies and making an honest assessment of one's own skills, tolerances, patience and humility is essential. Successful traders are willing to learn from their mistakes and admit when they have been wrong.
