Finance

What Is Day Trading: Its Advantages And Disadvantages

By Kurt Osterberg · On April 12, 2018

Day trading tends to be very popular when the market surges (e.g. the dot-com bubble or the cryptocurrency bubble). This is because everyone and their grandmother can make money trading when the market is going up. But it’s when the market’s going down that separates the truly skilled day traders from the beginners.

In this post we are going to look at:

What is day trading

What are its advantages and disadvantages.

How we can improve on day trading’s disadvantages.

What is day trading

Day trading is a strategy whereby the day trader makes multiple trades each day.

The position size for each trade is small, usually less than 5%. Each position size MUST be small because the trader has so many different positions.

Each trade only lasts a few hours or a few days. Hence, the time frame for a day trader is very short.

Each trade will only make small profits since the position size is so small and the time frame is so short. The day trader makes money by adding up profits across hundreds if not thousands of trades each year. This is akin to picking up a million nickels.

For one reason or another, day trading is seen as a “full-time job”. The day trader is glued to his or her computer screen all day, from the opening bell to the closing bell.

Many people choose to become day traders for different reasons:

Day trading is alluring because of the market’s short-term and intraday fluctuations. Traders dream of “vast profits” if they can capture each and every one of those short-term fluctuations.

Day trading tends to be a steadier source of “income” as opposed to medium-long term trading. Day traders tend to have more consistent returns because they don’t hold any position for a long period of time. The longer you hold your position, the more likely you are to experience a massive gain or a massive loss.

Day traders can use a discretionary approach or a quantitative approach.

Discretionary day traders either use price action or standard technical analysis to trade:

Day traders who use price action are in tune with the “feel” of the market. The day trader will go short if the market “feels” weak. The day trader will go long if the market “feels” strong. This is generally not the best way to day trade because the market will generally “feel” strong when it’s going up and “feel” weak when it’s going down. Remember, trading on your gut feeling is rarely a good idea.

Day traders who use standard technical analysis use trendline support/resistances (e.g. moving averages), patterns, and contrarian indicators like RSI. They essentially buy on support, sell on resistances, buy on breakouts, sell on breakdowns.

Others employ a quantitative (systematic) approach to day trading. This is what I do with the Day Trading Model. Day trading models allow the trader to backtest certain indicators for the optimal BUY and SELL signals. In addition, models allow the trader to backtest certain risk management strategies.

What are the advantages and disadvantages of day trading

Some people decide to become day traders due to the advantages that day trading has over trading strategies with longer time frames. If done properly…

Day trading leads to lower risk

Day trading leads to more consistent returns, almost like an “income stream”.

Day trading is more suitable for periods of high market volatility.

Day trading leads to lower risk

Successful day traders spread their capital across multiple small positions. For example, a common rule of thumb is “don’t risk more than 5% of your portfolio on any single position”. Another rule of thumb for day trading is “always hold at least 5 different positions”.