Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Day Trader

What it is:

Day trader is a term applied to a very active securities trader who holds securities for a short period of time. Day traders will often open and close a position within the same day.

How it works (Example):

While many day traders focus on stocks, the practice is not limited to equities. Some day traders also buy and sell bonds, foreign currencies, commodities, options, and even derivatives contracts.

There are several types of day traders. Some are called scalpers; they attempt to earn small profits on large volumes of securities. Meanwhile, momentum traders look for securities that are exhibiting strong trends on a particular day and attempt to profit from those trends. Day traders often use technical analysis to determine which securities to trade, as well as to pinpoint the ideal entry/exit points for their transactions.

Day traders tend to execute most of their transactions through low-cost online discount brokers, as the higher commissions paid to traditional full-service brokers would soon become cost-prohibitive. Some day traders avoid using market makers or brokers entirely by purchasing memberships in direct-access broker systems. These systems route orders to an electronic communications network (ECN), which is a computerized matching system that allows traders to advertise bid or ask prices and execute trades.

Most day traders close out their positions at the end of the trading day to avoid the potential negative effects of news, earnings announcements, or changes in investor sentiment that may occur overnight. Those willing to bear this risk and hold securities for up to several days are often referred to as swing traders.

Why it Matters:

During the bull market of the late 1990s, day trading became an increasingly popular way to generate quick and easy profits. However, many day traders had little formal financial training or investment expertise, and a large number were wiped out by the brutal bear market that ensued from 2000-2003. Some people consider day trading nothing more than another form of gambling, and claim that its introduction has increased volatility in the markets. Meanwhile, others believe it to be a legitimate means of capitalizing on short-term trading patterns.

In either case, day trading requires solid analytical skills and strict discipline, particularly for those that want to make a career of it. Given the exceptionally speculative nature of market timing, day trading is probably not prudent for those without the considerable financial expertise and emotional stamina needed to withstand the substantial risks involved.