What Is Day Trading & How Does It Work?

Day trading demands an analytical approach as well as plenty of discipline and skill. It's a strategy that's often best suited to more experienced traders, and it is seen by many as laden with risk. But that means there is ample opportunity too. So, what is day trading, how does it work and what are the pros and cons? Read on to find out more.

What is day trading?

Day trading refers to the practice of opening and closing positions within the same day. It is a short-term approach, with trades only held for a few hours at most, and never overnight. There is no limit to how many times you can trade in a day, and those who implement this strategy will typically open and close multiple positions throughout a session.

Because of its short-term nature, the profits made on any individual position may be smaller in comparison to some long-term positions, but the aim is to accumulate these smaller profits in high volume. And in some particularly volatile markets, one-off price fluctuations can still be large enough for you to make significant profits – or losses.

Day trading is an intensive approach in that it demands a great deal of analysis and understanding, plus the capacity to make multiple decisions over a relatively short period. It is therefore not a strategy that should be entered into lightly, although recent research revealed that 1.8 million adults began day trading in the UK during the Covid-19 pandemic.

Popular day trading strategies

Day trading can be executed in several different ways. It is an overarching approach, but there are variations in its implementation. It is important for you to choose that which best suits your level of knowledge, the time available to you, and is geared towards achieving your objectives. Common day trading strategies include:

• Trend trading: Using the prevalent trend of an asset's performance to open positions in line with that movement e.g. going long on an upward trend or short on a downward one. Find out more in our guide to trend trading.
• Swing trading: Identifying where there is set to be a reversal in the prevalent trend – even if relatively small – and opening positions to suit. Find out more in our guide to swing trading.
• Range trading: Determining the resistance and support levels of an asset's value and opening and closing positions within that range. Find out more in our guide to range trading.

What are the best indicators for day trading?

Day trading requires a very different approach to long-term trading or investing. You need to narrow your focus to look at how an asset's value fluctuates daily rather than over weeks or months. With that in mind, there are plenty of factors that you need to take into consideration. For example:

• Volatility: If an asset's value moves suddenly and significantly, it can create opportunities for you to make a profit. The flip side, of course, is that if it moves against you then you could soon incur considerable losses. Some assets – such as minor currency pairs, for example – display greater volatility than others, so you need to be aware that these are more susceptible to sudden shifts.
• Liquidity: Day trading is all about executing multiple trades, so you need to be able to open and close positions quickly. If an asset is highly liquid – for example, a major currency pair like USD/EUR – it makes it a more viable option to include as part of your day trading strategy.
• Volume: If an asset is being bought and sold with great regularity, it helps to inform your analysis. It means you have more data from which to identify patterns and the support and resistance levels. You can then use these to determine your entries and exits.

Tools and software to inform your day trading strategy

It can take a long time to learn day trading, and the chances are you will make some mistakes along the way. But the key is to take the lessons from those and use them to shape your decisions in the future. Day trading can be complex, but there are several tools you can use to assist you:

• News monitoring can help you keep abreast of various developments such as economic policies, changes in legislation, political upheaval, major weather events and more. This will play a crucial role in your fundamental analysis .
• Analytical tools such as charts and graphs support your technical analysis and give you a visual insight into how an asset's performance has fluctuated over time. You can use filters to view price changes by the minute if you wish – a function that perfectly suits the short-term nature of day trading.
• Trading software is available in various forms. You can harness programs that carry out backtesting – essentially simulating your day trading strategy using past performance. This cannot offer any guarantees of future performance, but it can give you an idea as to whether your approach might prove successful. There is also automatic pattern recognition software as well as systems that integrate directly with your broker for rapid trade execution.

What are the benefits of day trading?

Day trading offers several potential advantages, such as:

• No overnight fees: All positions are opened and closed within the same day, which means none are left open overnight and you avoid the fees some brokers will charge for maintaining a position from one day to the next.
• No gapping: You can incur losses if, upon the market reopening, an asset's value has moved above or below the price at the previous day's close. But with day trading, this is not an issue as no positions are left open overnight.
• Fast pace: Day trading appeals to those who like to see a swift outcome on their positions and make a series of quick decisions based on those outcomes.
• Access multiple markets: You can day trade a number of different CFDs on forex, shares, and commodities. This offers the opportunity to diversify your portfolio.

What are the risks of day trading?

As we've already touched upon, there are inherent risks to day trading. It's important for you to understand the drawbacks that could hinder your chances of success. These include:

• Volatility: The sometimes-unpredictable nature of the markets can offer opportunities, but the downside is that you can also incur losses just as suddenly. It's important to make sure you know which assets are more volatile and take steps to mitigate that risk.
• Time pressures: The nature of day trading means you need to devote lots of time and effort to your analysis and monitoring of the markets so that you can make decisions when you need to. This can prove a major drain on your resources, especially if you have other important commitments in your life.
• Trading on leverage: You can day trade on margin, which means only putting up a fraction of the necessary capital to gain greater market exposure. While this can offer the chance to amplify your profits, the losses will also be calculated on the value of your full position. So, you could stand to lose a lot more than just your initial outlay.
• Additional charges: Most day trading strategies centre around executing multiple short-term trades. This could mean that your transaction fees begin to mount up and eat into any profits you do make.

How can you guard against the risks of day trading?

You need to accept that certain factors will always fall outside of your control – especially when it comes to the volatile nature of some markets. But there are steps you can take to increase your chances of making profits, or at the very least minimise your losses. For example:

• Thorough research: Day trading should not be done on a whim. To be consistently successful you will need to rely on accurate, insightful analysis to inform rational decisions.
• Give yourself time: That level of research requires time and effort, so make sure you are willing to devote enough of each to implement your day trading strategy properly. The same goes for your trading sessions, which may require you to monitor trends and open or close positions over an extended period of the day.
• Stop losses: These are conditions you can set to automatically close a position when an asset's price reaches a certain value. Essentially, this is a method of limiting your losses if the market moves significantly against you.

Is day trading suited to all markets?

One of the great advantages of day trading is that you can use it to access a wide variety of markets . It might be that some asset classes are more suited to day trading than others. For example, forex  is considered the most liquid market in the world and therefore can be traded in high volume throughout any given session. But in theory you can also day trade the likes of:

• Shares
• Indices
• Commodities

Shares, Indices and Commodities cannot be directly traded via Tradu. Tradu services are limited to listed stocks and CFDs on Shares, Indices and commodities.

Which instruments can be used in day trading?

If you do not want to invest directly as part of your day trading strategy, you can choose to use derivative products, such as contracts for difference (CFDs). This means you are not taking ownership of the underlying asset as you would when you invest. Instead, you are merely speculating on the future performance of an asset.

CFD trading is where a buyer and seller agree to exchange the difference in an asset's value. That difference is calculated from the price at which the contract is opened to when it is closed.

CFDs are leveraged products, which means you can magnify your profits for a relatively small outlay. However, there is also the risk of amplifying your losses if a trade goes against you. This is because profits and losses are calculated based on the value of the full position, not just the initial deposit you contribute. Check out our guide to CFDs to find out more.

How many times can you trade in a day?

In theory, there is no limit to how many times you can trade in a day. Each trader will have their own approach. Some may choose to focus on one asset at a time, trading exclusively on its fluctuations throughout the day. Others may move between multiple assets, opening and closing positions at varying intervals. You can hold positions for hours, minutes or even a matter of seconds – so the number of individual trades is not restricted, other than by the time available to you.

Learn more about how to start day trading with Tradu

Tradu can offer everything you need to implement your day trading strategy. Our proprietary platform  offers access to a wide range of markets, plus a host of analytical tools to inform your research, monitor patterns and help you identify trends. You can open your account today and if you want to further your education, check out our extensive archive of trading guides.