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What Is Day Trading?

Just about anyone can invest in the stock market. When it comes to something like day trading, however, you may find it’s best to leave that to the pros. Day trading is a complex practice that requires strategy and extensive background knowledge of how market indices operate. If you think it could be a good way for you to build your portfolio or make some extra money, it’s important to know that it’s risky.

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How Day Trading Works

Typically, when someone buys a security, that person holds onto it for a period of time that could last for months or potentially years. But anyone involved in day trading is completing the whole process – buying and selling their investment – within a single day.

To an outsider or a beginner investor, this might not sound like a big deal, but it is. Day trading is short-term trading. It takes a certain level of skill and expertise to be able to make trading decisions quickly and successfully. If you were trying to trade stocks, for instance, you would have to be aware of which shares are more likely to have high liquidity and volatility, meaning that you would choose ones that can be easily sold at the price you want and that tend to experience dramatic and rapid shifts in price throughout the day.

After settling on a security to work with, day traders figure out whether to begin trading with buying or selling. If you start with buying to gain some traction in the market, you are said to be “going long” or “buying long.” If you’re trying to reach a certain level by selling, you would be “going short.” Traders then determine how they’re going to make money using their chosen strategy.

Who Is Day Trading?

Day traders in the past have typically been bankers and experienced financial analysts. Some have done their trading via financial institutions while others have done it on their own and engaged in day trading online, in the comfort of their own home.

Over time, more beginner traders and investors have gotten into the day trading game. But before you decide to jump in, it’s important to know what it takes to day trade successfully so you’re not making mistakes that could really cost you.

It helps to have a firm understanding of how markets and exchanges function, unless you don’t mind walking away from your trades with less money in your pocket. You’ll need to be able to interpret and make the best use of information from different news outlets that will tell you what’s happening with the markets throughout the day.

It’s also a good idea to have a solid strategy and access to technology that can help you make the best moves based on trends, patterns and past successes, as well as a decent amount of cash available. Day traders often resort to borrowing money (also known as leverage) from brokers so that they can afford stocks and other securities.

Related Article: How the Stock Market Works

Day Trading Strategies

There are several different ways to buy and sell securities such as stocks, futures and exchange traded funds (ETFs) as a day trader. If you’re someone who’s comfortable making split-second decisions, you might enjoy scalping. This involves keeping securities for mere seconds or minutes and making money by trying to purchase or get rid of them when they reach your desired price.

Another option, trend trading (or trading on momentum) is based around keeping up with trends. Whether you decide to buy or sell will depend on where prices have been going for a number of days. If they’ve been consistently going up, you would buy your security. Or you could do the opposite of the trend and go against the grain by selling your shares or other securities when prices are higher. This is called fading.

As you’ve probably noticed, day trading comes with its own terminology. Here’s another term for you: Arbitrage is a strategy where a day trader will buy a security and then simultaneously sell it at a higher price in a different market to make a profit. You’re taking advantage of price differences to earn money quickly.

And of course, earning a fast buck is the ultimate aim of day trading. Trading daily pivots is another option that allows traders to buy or sell according to daily highs and lows. More specifically, you’re selling when prices reach their peak and buying when they’re at their lowest point.

Find Out Now: How much should I save for retirement?

The Risks of Day Trading

Day trading drives markets and helps them to maintain their liquidity, making it relatively easy for securities to be bought and sold. It serves its purpose, but it may not be the right thing to get involved in if you’re risk-averse or new to the world of investing.

Not only can day trading be expensive, but you could also potentially end up with more debt since leverage is common and making a profit is not guaranteed. Be ready to lose a lot before you gain much ground, particularly when you first get started. And remember that when you day trade you’re competing against more experienced traders – and sophisticated computer algorithms.

Bottom Line

It may sound appealing to stay at home in your sweatpants making money on your laptop as a day trader. The reality, though, is that the average investor is unlikely to make it rich this way. That means day trading may not be the best strategy for growing your nest egg.

If you’re on track to meet financial goals like saving for retirement, you’re paying all your bills and you have a sufficient emergency fund, you may consider taking the extra money in your budget to see how far you get with day trading – as long as you know your limits and are able to stop before you lose more than you can afford to lose.

Photo credit: ©iStock.com/GlobalStock

Amanda Dixon Amanda Dixon is the editorial assistant at SmartAsset. She studied journalism and sociology at the University of Georgia. Born and raised in metro Atlanta, Amanda currently lives in Brooklyn.

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