Day trading is one of the most attractive trading styles out there, allowing traders to open and close trades during the same trading day, track results on a daily basis, and utilise a range of trading strategies.
Many beginners in trading get their feet wet with day trading before gradually switching to other trading styles, such as scalping or swing trading. Day trading is simply a sweet spot for many traders, offering the best of both short-term and long-term trading.
Here, we’ll dig deeper into the main advantages and disadvantages of day trading. By the end of the article, you should be able to answer whether day trading is the right choice for you.
What is Day Trading?
Day trading is one of the most popular trading styles used by traders around the world. Day trading involves opening a trade or multiple trades during a day and closing them by the end of the current trading day. As a result, traders can immediately measure their trading performance by the end of the day, unlike in swing trading or position trading where trades are held for days or weeks.
In addition, day trading offers a fast-paced trading environment where traders don’t have to wait for a long period of time to find and open a trade. While this trading style isn’t as fast and aggressive as scalping, it’s still a sweet spot for many traders who want to get some action in the markets.
The higher number of trades, however, also implies relatively larger trading costs, which is one of the main drawbacks of day trading. We’ll dig deeper into the main advantages and disadvantages of day trading in the following lines.
Day Trading vs Other Trading Styles
There are four main trading styles available to traders:
- Day trading
- Swing trading
- Position trading
All styles have their specific pros and cons. Scalping is the fastest trading style where traders often hold trades for minutes or even seconds. The disadvantage of this trading style is that trading costs can quickly sum up and market noise can trigger stop-losses without an apparent reason.
When compared to scalping, day trading has a slightly longer holding period of trades (up to a few hours) and takes advantage of slightly longer-term timeframes, which partially eliminates the negative effects of market noise. However, even day traders can sometimes face erratic price behaviour that can accumulate losing positions.
Swing trading is based on taking advantage of swing movements in the markets. Those swings can last from a few days to a few weeks, which is a typical holding period of swing trades. As a result, swing trading has slightly lower trading costs than day trading, but the number of tradeable opportunities is also lower since swing traders base their decisions on longer-term timeframes.
Finally, position trading is the longest-term trading style out of the four. Position traders usually have a good understanding of market fundamentals, which are the major driver of price movements in the long-term. It’s not unusual for position traders to hold their positions for months or even years. To be able to do so, position traders need to have a higher trading account to withstand negative price fluctuations and follow macro-fundamentals such as GDP reports, inflation trends, labour market statistics, and monetary policy reports.
Advantages of Day Trading
- Trading Strategies
Day trading allows you to use a variety of trading strategies across all major markets. Popular day trading strategies include breakout trading, trend-following, and counter-trend trading (or mean-reversion).
In breakout trading, traders try to catch the initial volatility that occurs immediately after the price breaks an important technical level, such as chart patterns.
Pending orders tend to cluster above and below important levels, which leads to a surge in momentum and volatility after the price hits those levels and triggers the pending orders. Breakout trading also allows day traders to set a pending order to catch a breakout once it occurs, as pending orders become market orders once the price reaches the pre-specified level.
Popular technical tools used by breakout traders include chart patterns, such as head and shoulders patterns, triangles, double tops and bottoms, triple tops and bottoms, rectangles, wedges, and flags. In addition, breakout traders can also take advantage of the volatility that occurs after the price breaks above or below a channel, trendline, or horizontal support or resistance levels. Trend-following strategies, as their name suggests, involve opening day trades in the direction of the underlying intra-day trend. Trend-following is perhaps the most popular trading strategy among day traders as it returns an attractive risk-to-reward ratio with a relatively high success rate.
To open a trade in the direction of the underlying trend, wait for the price to complete a pullback (e.g. to an important intraday Fibonacci level) and use candlestick patterns to make sure the underlying trend is about to continue.
Counter-trend trading strategies involve opening trades in the opposite direction of the underlying trend. Counter-trend traders aim to catch market corrections that occur after a prolonged and strong uptrend or downtrend. This trading strategy is slightly riskier than breakout trading and trend-following and should be used only by experienced day traders.
- More Trading Opportunities
Since day trading is a relatively fast-paced trading style, it offers a large number of trading opportunities – every day.
Day traders base their decisions mostly on intraday timeframes, such as the 15-min, 30-min, 1-hour, and 4-hour ones. Those timeframes offer much more tradeable setups than the daily or weekly charts used by swing traders and position traders, which is a major advantage of day trading.
However, bear in mind that shorter-term timeframes usually include more market noise which can quickly accumulate losses if you set your stop-loss levels too tight. To avoid this, try to measure the average volatility of the security that you’re trading (using the ATR indicator, for example), and place your stop-losses accordingly.
A higher number of trading opportunities doesn’t necessarily mean more profits. Always follow your trading plan and only place trades that are fully in-line with your strategy. Risk management also plays an important role in day trading success, so make sure to risk a small percentage of your trading account on any single trade.
- Performance Measure
Day trading involves opening and closing trades during the same trading day, which means that you get your daily results relatively fast. Many traders like to know whether they’re in profit or loss on a daily basis, and day trading allows exactly that.
In longer-term trading styles, traders often face periods of negative price-movements, which doesn’t only require a higher trading account to withstand those movements, but also a lot of patience and discipline to stick to their trades even when times become tough. To measure your performance, create and keep a trading journal with all of the trades that you take during a day. Not only will you be able to track your performance, but you can also look for trading patterns that tend to reduce your profits or lead to losses that can be avoided.
- Overreaction to News
Markets consist mostly of human traders, and humans tend to overreact to news. That’s why you’ll see large price-movements around certain news, even if those news shows to be relatively unimportant for the markets. As a day trader, you can take advantage of that behaviour and squeeze out additional profits.
The main thing to know when trading the news is that the actual number is not important. It’s the actual number relative to the forecast that matters. If, for example, the US non-farm payrolls come in at 200k but markets forecasted an increase of only 120k, that’s better than expected and will likely have a large impact on the value of the US dollar.
- Technical Setups
As a short-term trading style, day trading is largely affected by technical levels. As the trading timeframe becomes longer, the focus shifts from technical levels more towards fundamentals. In the very short-term, market noise tends to lead to price movements. Over the medium-term, mean-reverting becomes increasingly important, and in the long run, changes and trends in fundamentals create trends in the underlying security.
When using technical analysis in day trading, try to combine a number of technical tools and only take a trade once all or the majority of tools confirm a setup. This is also known as a confluence of technical levels.
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Disadvantages of Day Trading
- Higher Trading Costs
When day trading the market, you’ll have higher trading costs than when swing or position trading the market. Since day trading involves opening more trades during the day, choose a broker that has tight spreads and low trading fees.
Some brokers offer fixed spreads, which can be interesting for traders who want to trade around important news releases and keep trading costs low. News releases tend to lead to high market volatility, slippage, higher trading costs, which is something you need to understand if you’re planning to trade important market reports. In the long run, those trading costs can quickly add up and reduce your profits.
- Limited Profit Potential
Given the shorter holding periods of trades and shorter timeframes on which day traders base their decisions, day trading has a more limited profit potential compared to swing trading. In addition, traders close their trades by the end of the trading day regardless of their profit. While this practice eliminates overnight risk, it also limits the potential profits of promising trade setups.
- Risk of Over-leveraging Your Trades
Most markets don’t fluctuate much over the day. As a result, day traders utilise more leverage to squeeze out the most profits and take advantage of those small price movements. While leverage can be very efficient, traders who over-leverage their trades also risk larger losses.
Leverage is a double-edged sword and should be used only according to your trading plan. Make sure to create a strict risk management plan to cap your leverage or risk-per-trade in such a way that eliminates the risk of ruin (i.e. blowing your account.)
- Market Noise
The shorter the timeframe you’re trading on the more market noise you have to deal with. Market noise represents erratic and unpredictable price behaviour without any technical reasoning or news that could have led to those movements.
Market noise presents a real problem for short-term traders, and the only way to avoid getting stopped out too early is to widen your stop-loss level. Take a look at the previous volatility in the pair, and try to set your stop-loss above or below recent support and resistance levels, giving the market enough space to perform.
Final Words: Should You Day Trade the Market?
Let’s admit it, we’ve all started trading with a day trading style, opening and closing multiple positions during the same trading day. Some traders who found that approach to be too fast-paced gradually switched to longer-term styles over time, such as swing trading.
While fundamentals (such as news reports, for example) can have a significant impact when day trading, fundamental analysis becomes proportionally more important as you zoom out to longer timeframes. Most day traders are technicians and sometimes incorporate some news trading around important market reports.
Still, bear in mind that day trading requires discipline, patience, and a good understanding of the markets in order to return positive results over the long run. If you’re still new to the markets, swing trading could be a better choice to gain trading experience before switching to a faster trading style like day trading.
Swing trading gives you more time to make trading decisions and to get out of a trade if you realise that your analysis is wrong. Therefore, try becoming profitable with a longer-term trading style before switching to shorter-term ones.