What is Day Trading?
It’s possible to break down trading strategies into four main types: Day, Trend, Swing and Position
What is Day Trading?
Most traders tend to identify and stick to a single approach rather than mixing them up. However, it’s also fair to say that there is a degree of overlap between the four, at least when it comes to using technical indicators or focusing on fundamentals. It can be useful to look at what is involved in each approach to see how it suits you, your lifestyle and your attitude to risk. After all, you may not have enough free time to day trade. By the same token, you may be uncomfortable taking on the amount of risk which may be required to run longer-term position or trend-based trading strategies. In this guide we’ll consider Day and Trend trading and look at some of the key differences between them. We’ll cover Swing and Position trading in a separate post.
Day trading means opening and closing trades within a day, or a single trading session. This avoids the extra costs together with the added uncertainty that comes with holding a position overnight. In fact, some day traders may only run a position for a few hours or even minutes.
Day traders are constantly on the look-out for short-term opportunities. They tend to trade frequently and act when they consider a market to be oversold or overbought. Then they jump in to buy or sell in the hope of turning a quick profit. A day trader will typically have a tight risk/reward ratio. That is, they may be happy to risk £50 to make £50, although a 1:2 risk/reward ratio is more common and indeed more sensible. Due to the high frequency of trades and the tight risk/reward ratio, disciplined risk management is extremely important. Day traders often use charts with short timeframes (5 minute, 15 minute and hourly) to identify intermediate areas of support and resistance and trade accordingly. Day traders tend to work on the assumption that markets overshoot and undershoot specific price levels (which they identify on charts) and then quickly correct. Day traders have to be prepared to use tight stops in order to avoid losing money if a market breaks out of its short-term trading range. They have to be extremely disciplined in choosing their entry and stop levels. They must be prepared to take a series of small losses and always have a profit target for every trade. Day trading won’t suit anyone who hasn’t got time to keep a close eye on the markets throughout the trading session.
There are a group of traders who specifically look for opportunities when a market shows signs of trending in a particular direction. They try to identify those times when momentum is building in a market on one side rather than another. Typically this comes when a financial instrument breaks out of a range after a period of consolidation and as sentiment turns increasingly positive (for a “buy” trade) or negative (for a “sell”). It doesn’t matter whether the direction is up or down as a trend trader only wants to establish that a market looks set to move broadly in a particular direction over a period of time. This can be short, medium or longer-term. Once the position is placed, the trader will then run it until there is evidence to show that the trend has run its course. Strictly speaking, trend traders put aside market fundamentals and instead concentrate on price action alone. They often use specific drawing tools and/or technical indicators to help them decide when a trend is establishing, and if so, which direction is it going in? For instance, the Directional Movement Indicator is useful for signalling if a market is ranging or trending. Then a drawing tool such as Andrews’ Pitchfork can be used to establish the likely direction and strength of a trend together with lines of support and resistance. These can help to establish when a trend has run its course. As with any strategy, risk and money management is important with trend trading. In contrast to day traders, trend traders are prepared to put up more risk capital per trade, but aim for a bigger percentage return.