How to Day Trade Safely

Investing, Investing Strategy
how to day trade safely

While it’s easy to become enchanted by the idea of turning quick profits via the stock market, day trading makes virtually no one rich.  Research suggests that 99% of day traders fail to consistently make money and the vast majority lose money.

However, if you must try day trading, there are some critical rules you should follow to ensure you don’t get in over your head. Here is how to approach day trading in the safest way possible.

Ground rules for day trading

There are countless tips and tricks for maximizing your day trading profits. None is as important as these tactics for managing the substantial risks inherent to day trading:

  • Trade with money you can afford to lose. This is paramount: Have a certain amount of money set aside for day trading and don’t trade more than that amount. Don’t use the mortgage or rent money to trade. Why? It’s entirely possible you will lose it.
  • Start small. Especially as you begin to day trade, you will make mistakes and lose money. Keep an especially tight rein on losses until you gain some experience.
  • Don’t quit your day job. You may have a run of luck, especially as the market engages in a sustained bull run. But you’ll need to see how your trading strategy performs when the market gets rough, especially during a recession, before you consider expanding your efforts.

“It’s easy to win and lose quickly,” says Ross Cameron, a full-time day trader and founder of Warrior Trading, a company that educates would-be traders. “Beginners should prove that they can be consistently profitable before they ramp up their trading.”

With these rules in mind for limiting your losses, you can begin to design your strategy for making profitable trades.

What to day trade

To begin trading, you’ll first need to decide what types of securities you’re going to buy and sell. That could be stocks, bonds, commodities, currencies or something else.

Typically, an attractive security for day trading has the following characteristics:

  • Good liquidity or volume. Stocks are popular to day trade because they’re liquid, meaning they trade often and in high volume. Liquidity allows a trader to move in and out of a position without affecting the price much. Currency markets are also highly liquid.
  • Some volatility — but not too much. Volatility means the security’s price changes frequently. This kind of movement is necessary for a day trader to make any profit. Someone has to be willing to pay a different price after you take a position.
  • Familiarity. You’ll want to understand how the security trades, either due to the underlying business or from the perspective of technical analysis. Will an earnings report hurt the company or help it? Is a stock stuck in a trading range, bouncing consistently between two prices? Knowing a stock can help you trade it. (Here’s how to research a stock.)
  • Increasing interest or newsworthiness. Media coverage gets people interested in buying or selling a security. That helps create volatility and liquidity. Many day traders follow the news to find ideas on which they can act.

Stocks are among the most popular securities, because the market is big and active, while commissions are relatively low. Day traders who focus on stocks often rely on what’s called “technical analysis,” or analyzing the movements of stocks on a chart, rather than “fundamental analysis,” which involves examining company factors such as its products, industry and management.

While some day traders might exchange dozens of different securities in a day, others stick to just a few.

“Everyone has to trade their own way, and I stick to just a few stocks,” says Ed Trirogoff, a full-time Los Angeles-based day trader. “But I know them like an expert.”

Knowing your stocks well helps you gauge when to buy and sell them, how a stock has traded in the past and how it might trade in the future.

Popular day trading strategies

When you’ve found securities to trade, you’ll need to determine which trading strategy will work with them and maximize your chances of trading profitably. Some day traders specialize in a specific type of strategy that they’ve found works for them, while others use many types of strategies.

Here are some typical day trading strategies.

Swing, or range, tradingTraders find a stock that tends to bounce around between a low and a high price, called a "range bound" stock, and they buy when it nears the low and sell when it nears the high. They may also sell short when the stock reaches the high point, trying to profit as the stock falls to the low and then close out the short position.
Spread tradingThis high-speed technique tries to profit on temporary changes in sentiment, exploiting the difference in the bid-ask price for a stock, also called a spread. For example, if a buyer’s bid price drops suddenly, the day trader might step in to buy and then try to quickly resell at the stock’s ask price or higher, earning a small “spread” on the transaction.
FadingThis sees a trader short-selling a stock that has gone up too quickly when buying interest starts to wane. The trader might close the short position when the stock falls or when buying interest picks up.
Momentum, or trend followingThis strategy tries to ride the wave of a stock that’s moving, either up or down, perhaps to due to an earnings report or some other news. Traders will buy a rising stock or “fade” a falling one, anticipating that the momentum will continue.

Some traders might use these strategies to angle for a penny per share, like spread traders, while others need to see a larger profit before they close a position, like swing traders. Some traders might be willing to hold overnight, while others won’t and prefer to maintain a neutral position in case bad news hits before they can react.

To know when to trade, day traders will closely watch a stock’s order flow, the list of potential orders lining up to buy and sell a stock. Before they buy, they’ll look for a stock to fall to “support,” a stock price where other buyers step in to buy, and the stock is more likely to rise, they estimate. To sell, they’ll look for when the stock hits “resistance,” a price where more traders start selling and the price is more likely to fall. To make judgments like this, you’ll want a broker that lets you see order flow.

Whichever strategy you pick, the important thing is to find one or more strategies that work and that you have the confidence to use.

“You have to have the confidence that your strategy works,” says Trirogoff. “Otherwise, you won’t use it and you’ll be tempted to try other untested strategies. You have to be comfortable making your trades.”

It can take awhile to find a strategy and security that work for you, and even then the market may change, forcing you to change your approach.

The best times to day trade

Day traders need liquidity and volatility, and the stock market offers those most frequently in the first couple of hours after it opens, from 9:30 a.m. to about noon ET, and then in the last hour of trading before the close at 4 p.m. ET.

Even in just this narrow window of time, a day trader might make 100 to a few hundred trades in a day, depending on the strategy and how frequently attractive opportunities appear. With so many trades, it’s important that day traders focus on finding a broker with low commissions or a broker focused on their needs. (See NerdWallet’s analysis of the best brokers for day trading for some strong candidates.)

Risk management

While the ground rules at the top can help you avoid some of the biggest catastrophes in day trading, it’s important to manage smaller risks carefully as well.

Risk management is all about limiting your potential downside, or the amount of money you could lose on any one trade or position. When you’re considering your risk, think about the following issues:

  • Position sizing. If the trade goes wrong, how much will you lose?
  • Percentage of portfolio. Closely related to position sizing, how much will your overall portfolio suffer if a position goes bad?
  • Losses. What level of losses are you willing to endure before you sell?
  • Selling. After making a profitable trade, at what point do you sell?

Even with a good strategy and the right securities, trades will not always go your way. So it’s important to have a plan for when to close a position, whether it’s purely mechanical — for example, sell after it goes up or down X% — or based on how the stock or market is trading that day.

Proper risk management prevents small losses from turning into large ones and preserves capital for future trades. But that means traders have to be willing to realize a loss, which is hard for many traders to accept, even though it’s essential to long-term survival.

“When you’re wrong, you have to cut your losses almost immediately,” Trirogoff says.

Tips for easing into day trading

If you’re not quite ready to be a prime-time player, you can always take a spin as a paper day trader first. Paper trading involves simulated stock trades, which let you see how the market works before risking real money. Paper trading accounts are available at many brokerages. You can also get a feel for the broker’s platform and functionality with this approach.

“My top tip for beginners is to use a simulator, at least a month,” says Cameron of Warrior Trading. “Show that you can become profitable.”

While it can be useful to test day trading under simulated conditions, there’s still no substitute for real-life trading where you have money at stake. Here are some additional tips to consider before you step into that realm:

  • Establish your strategy before you start. Losing money scares people into making bad decisions, and you have to lose money sometimes when you day trade. Having an exit plan for each of your investment holdings is important because it helps you avoid making an emotional decision when you need to make a rational decision.
  • Be patient. Look for trading opportunities that meet your strategic criteria. If the situation doesn’t meet it, don’t trade. You don’t have to trade if nothing looks attractive.
  • Read, read, read. Continually watch what’s happening in the markets. Big news — even unrelated to your investments — could change the whole tenor of the market, moving your positions without any company-specific news.

Unsure if day trading is for you?

Day trading is just one way to invest — and it’s hardly worth recommending for most investors. There are many less-intense approaches to the stock market and investing in general. Here are some resources to help you weigh other, simpler approaches to growing your money:

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