A day trader is someone who buys and sells stocks, options, or other financial instruments in a short time frame--typically within the same trading session--using trading patterns and other types of technical analysis to determine profitable strategies. The goal for this type of stock trader is to generate a consistent return based on successful trading strategies. By nature, the investment strategies used by day traders differentiate them from investors, who usually utilize strategies with much longer time horizons.
Day Trading for Profit
As opposed to another type of short-term stock trader and investors, fundamental analysis isn't used all that much by day traders. Their time frame is simply too short. Instead, day traders analyze trading patterns and other technical indicators to judge where a stock's price is going, and try to capitalize on them. For example, trading patterns and indicators like a "head and shoulders," "flag," "support level," and "resistance level" are used by traders to determine the direction of stock prices. Unlike investors, a day trader may buy and hold their stocks anywhere from just hours, minutes, and, in some cases, even only seconds before selling their shares to capture a profit or realize a loss.
There are also different types of day traders too.
- Institutional Day Trader: These traders typically work for investment firms, meaning they have more resources at their disposal but also means that they aren't entitled to all of their trading profits.
- Retail Day Trader: Self-directed traders that trade with their own capital, and usually have limited resources. Retail traders can operate from anywhere that has access to their accounts.
- Proprietary Trader: Prop shop traders trade in groups in a single location with resources provided from their proprietary trading firms. They typically trade out of the firm's account.
- Quantitative Trader: Also known as quant trading or blackbox trading, these types of traders rely on algorithms that usually trigger pre-programmed buying and selling points.
Pros and Cons of Day Trading
Day traders generally pay more in commissions and brokerage fees due to the high trading volume of their strategies. There is also a high level of risk associated with day trading due to its nature of timing the behavior of stock or asset prices. As such, the Securities and Exchange Commission has established what is known as the Pattern Day Trader Rule, which requires any trader who executes four or more same-day trades within five business days to have at least $25,000 of equity in their account. In addition, day traders are also taxed differently than regular investors, but are eligible for certain deductions as well.