With vast amounts of information being at our fingertips these days, you’re bound to hear about day trading at some point. Unfortunately, the variety and complexity of these voices may make it difficult for you to separate truths from myths and misconceptions. Yet, to move from rookie to a successful trader, you must get the facts right in all aspects.
For starters, what’s a day trade? When you purchase and sell the same security or open and close an options contract(s) within one trading day, you’ve performed a day trade. Buying a security without selling it later the same day won’t be considered a day trade. While day trading strategies have been largely associated with advanced traders, beginners can equally master the art of day trading. Today’s blog provides insider tips beginners can use to master the day trading strategy.
When to Day Trade
When it comes to the best time to trade, profitability is usually a key consideration, and often depends on the liquidity and volatility of the market. In this case, the best time to day trade is in the hours after the market opens, from 9:30 a.m. to about noon ET. You can also trade in the last hour before the market closes at 4 p.m. ET. These hours provide day traders with the volatility and liquidity needed to reap some quick profits.
Depending on the strategy and how often lucrative opportunities appear, a day trader can easily make a few hundred trades in a single trading day. Unfortunately, too many trades may come at the expense of higher costs, so you’ll want to keep your trading costs low.
Be Aware of the PDT Rule
The pattern day trader (PDT) rule is very important to keep in mind when entering the day trading space. You can inadvertently violate the PDT rule even if you’re not a usual rule-breaker. Although the consequences of breaking the PDT rule vary, the action itself can be inconvenient for investors who’re not actively trading. Don’t let this misfortune hamper your day trading goals. Here’s what you should know.
You’re considered a pattern day trader if you execute four or more day trades within a 5-day trading period. You’re typically limited to no more than 3 day trades in a 5-trading day period, unless you hold at least $25,000 (less any cryptocurrency positions) in your margin account.
As tricky as this may sound, it simply means that within a 5-trading day period, once you place a 4th day trade, your broker will flag you as a pattern trader and you’ll need to maintain a portfolio value of over $25,000 at the close of the market to continue day trading the next day.
Your portfolio value might fluctuate above $25,000 at some point in a trading day, but brokers often only take into account the closing balance of the previous trading day. Also, the 5-trading day period doesn’t necessarily follow the calendar week. For instance, Tuesday through Monday could be a 5-trading day period.
Assuming you’ve violated the pattern day trader rules, now what? Well, the consequences depend on your brokerage. The consequences for first-time offenders might not be as dire assuming your brokerage carries a more lenient policy. However, your broker will likely flag you as a pattern day trader so that it can monitor your activities for any repeat or consistent offenses. So, tread carefully.
Some brokerages may also subject you to a minimum equity call, meaning you must deposit sufficient funds to carry the minimum account value of $25,000 — even if you won’t day trade regularly. Until then, your brokerage may suspend all trading privileges for the next 90 days. You’ll probably be limited to closing out your positions only. Your margin buying power might be suspended, limiting you to cash transactions alone.
When it comes to day trading, knowledge is power. Besides information on basic trading procedures, day traders must also stay on top of the latest news and events that affect the stock market, not forgetting the economic outlook and interest rate plans by the Fed.
Do your research and create a wish list you’d like to add to your portfolio and have the latest information regarding companies and the market at large. Visit reliable financial websites for insight and market commentary.
If you’re feeling a bit hesitant to use your real money to day trade, you may want to try a paper trade first. A paper trade is simply simulated trading that lets you practice buying and selling securities without risking real cash. While learning, beginner day traders can make paper trades and handwrite them to keep track of their hypothetical portfolio and trading positions. You can also use online trading simulators to keep track, too. Beginner day traders are often advised to paper trade until they master the basic strategies, while experienced traders can use this practice to work on new approaches and ideas.
Theoretically, paper trading can build actionable insight and improve skill sets at every step in a day trader’s journey, from rookie to pro. But does it always work as planned, or are the better alternatives? For starters, paper trading carries no risk, doesn’t evoke any stress, and consistent practice builds confidence and experience.
In contrast, paper trading may not address the larger market’s impact on individual securities. Additionally, paper traders often select ideal market entry and exit positions, thus missing the obstacles generated by the real market.
Despite its limitations, paper trading can benefit novices who spend a significant amount of time testing new ideas and strategies before risking their real money, thus gaining as much experience as possible.
Pick 1 Strategy
Successful day trading isn’t just about moving fast, it’s about picking a strategy and having the discipline to stick to it right from the start. It’s always advisable that you stick to your formula rather than chase multiple strategies and lose all profits. Besides, don’t let emotional investing get the better of you, to the extent that you ditch your strategy. The rule of thumb; plan your trade and trade your plan. There’s no shortcut.
Learn Risk Management
Risk management means mitigating your potential downside or the amount of money you might lose on any trade. When thinking about risk management, consider these areas:
- Position sizing. How much do you stand to lose if a trade goes south?
- Percentage of portfolio. Closely related to the position size, how much of a ding will your portfolio take if a trade goes wrong? In this case, it’s advisable you stick to the 1% risk rule — you shouldn’t risk more than 1% of your overall account value on one trade. The 1% risk rule protects you from a significant capital decline in unfavorable market conditions.
- Selling. Once you’ve made enough profit, at what point do you exit a position?
Even with a solid strategy, trades may not always go your way. That’s why you must always have a risk management mechanism to mitigate losses.
In day trading, it’s important to manage expectations and limitations, otherwise you’ll join the fray with an overnight-millionaire mindset. Managing your expectations can help you easily alter your perspective of the market depending on what price actions are indicating. After all, there’s no harm in expecting the market to move in a certain direction, what’s worse is insisting on maintaining your view even when price actions say otherwise.
Day trading isn’t a smooth ride — there are days when the market will swing your way and others when it will create headwinds. As a day trader, you must learn to maintain a cool head and keep the greed and fear away. Managing expectations also means that logic rather than emotion should govern your decisions.
Day trading is one of the ways investors can approach the stock market, but it’s equally difficult to master. It requires discipline, skill, and patience. While most of those who try face their fair share of challenges, the tips highlighted above can create tailwinds for a solid strategy. Most importantly, steer clear of breaking the day trading rules, or otherwise maintain your account value above $25,000. You’ll have fewer concerns should you need to execute a short-term trade.