What is Day Trading? Definition, Strategies, and Risks

What is a Day Trader?

A day trader is someone who actively buys and sells financial instruments, such as stocks or currencies, throughout the trading day. All positions are opened and closed within the same market session, preventing exposure to overnight risks.

A day trader, meaning they avoid holding positions after the market closes, minimizes potential losses from after-hours events. Day traders aim to profit from short-term price movements by executing multiple trades based on market fluctuations.

Unlike long-term investors, day traders do not hold positions overnight, minimizing overnight risk. This approach aligns with the day trading definition, which focuses on capitalizing on intraday market volatility without exposure to after-hours events that could impact prices.

Day trading requires quick decision-making, in-depth market knowledge, and effective risk management. It is known for its fast pace and potential for rapid gains, but it also involves high risks.

The New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA) classify day traders based on the frequency of their trades. A pattern day trader is someone who makes four or more day trades within five business days using a margin account, and those trades account for more than 6% of their total trading activity. Pattern day traders must maintain at least $25,000 in equity to continue trading.

How Does Day Trading Work?

Day trading involves buying and selling financial assets within the same trading session. The primary objective is to capitalize on small price movements by executing multiple trades. Unlike long-term investors who rely on fundamental analysis, day traders primarily use technical analysis, chart patterns, and market indicators. 

Core Principles of Day Trading:

• Volatility: Choosing assets with significant price movements creates opportunities for profit.
• Liquidity: High trading volume enables quick trade execution with minimal price impact.
• Timing: The most active trading periods, like the market open and close, often provide the best opportunities.

Example of a Day Trade:

1. Identify an Opportunity: A stock increases in value after positive news.
2. Entry Decision: Buy at $50 per share, anticipating a rise to $52.
3. Risk Management: Set a stop-loss at $49.50 to limit potential losses.
4. Execution: If the stock reaches $52, the position is sold for a $2,000 profit.
5. Review: Analyze the trade’s outcome to learn and refine future strategies.

This fast-paced trading style demands discipline, quick decision-making, and a thorough understanding of market trends.

Day Trading Strategies

Day traders may employ a wide variety of basic strategic trading approaches, including:

1. Scalping

The scalping strategy involves the day trader looking to profit from small price changes. Trades are executed quickly, often opened and closed within just a few minutes, sometimes even seconds.

For the strategy to be effective, a day trader must have a precise entry and exit strategy and must be careful to execute trades with precision. When looking to make a small profit, every penny of the bid and ask spread—both entering a trade and subsequently exiting it—counts. Scalpers should act quickly before a window of opportunity closes.

Example: A trader buys a stock at $14.50 and sells it at $15.00, making a $0.50 per-share gain. Scalpers often repeat this process multiple times throughout the day.

2. News-Based Trading

The news-based trading strategy involves the use of accurate, timely information from various news sources regarding events that are likely to affect the price movement of assets; events like acquisitions or earnings announcements cause increased volatility the day trader can benefit from.

Example: Several reliable news sources report that Company A is about to announce its intention to acquire Company B. The trader buys stock in Company B. When the announcement comes, Company B’s stock price rises sharply. The trader cashes out for a quick profit.

3. High-Frequency Trading (HFT)

High-frequency trading uses advanced algorithms and technology to rapidly execute large volumes of trades. The goal is to take advantage of small price discrepancies across markets. HFT requires significant computing power and direct market access and is often used by institutional traders.

Example: An algorithm detects a minor price difference for the same stock listed on two different exchanges. It buys the stock on the lower-priced exchange and sells it on the higher-priced exchange within milliseconds, profiting from the price gap before other traders can react.

How to Succeed as a Day Trader

To be successful and profitable, day traders need to be knowledgeable about the assets they trade and possess a wealth of trading experience. They must incorporate up-to-the-minute analytics and news feeds from various sources to ensure their market analysis is based on the latest reliable information.

Many day traders use technical analysis to generate signals of favorable trading probabilities. Others rely primarily on fundamental analysis and look to “trade the news” (open and close market positions based on relevant news releases). Some—typically, only those with more trading experience—simply rely on instinct to determine which plays to make.

Risk Management Essentials

What is day trading without proper risk management? By minimizing losses and protecting capital, traders can stay in the game even when stock markets are volatile. The best day traders prioritize risk management as much as they do finding profitable trades.

• Limit risk to 1-2% of total capital per trade.
• Use stop-loss and take-profit orders to automate trading decisions.
• Aim for a risk-to-reward ratio of at least 2:1 to maintain long-term profitability.

Advantages and Disadvantages of Day Trading

As with any approach to investing, day trading carries advantages and disadvantages. Understanding the pros and cons can help individuals decide whether this fast-paced trading style aligns with their financial goals and lifestyle.

Advantage: No Overnight Risk

 No risks associated with holding a position overnight. Since day traders close out their trading positions before the close of each trading day, they don’t need to worry about some overnight news event causing the market to open substantially lower or higher the next trading day—something that can cost them money in a position held overnight.

Corresponding Disadvantage: Sometimes, those overnight events that cause gaps up or down the following trading day are very profitable for traders holding positions overnight. Day traders will never reap such benefits, though.

Advantage: Compounding Returns 

Returns on investment compound more quickly (assuming your day trading is profitable). You may be able to take the profits from the previous trading day to trade a larger position the following day and generate even greater profits.

Corresponding Disadvantage: More frequent trading means higher trading costs in the form of commissions and fees. Paying all those extra charges may significantly reduce your profitability.

Advantage: Flexible Work Schedule

It may require less time overall to generate substantial profits. Some day traders only make one or two trades a day and generally make them early in the day. This flexibility can be appealing to those looking for a non-traditional schedule.

Corresponding Disadvantage: It may require more time than you have available for trading. Day traders must have the ability to pay attention to market action for at least part of the day. If not outright impossible, it may be very difficult for someone working a full-time job from 8:00 a.m. to 5:00 p.m.

Risk vs. Reward in Day Trading

Day trading is portrayed as “the road to riches,” particularly after experiencing a surge in popularity in the 1980s. It offers traders the potential for high returns by capitalizing on short-term price movements, which can far exceed the gains achievable through traditional “buy and hold” investment strategies.

However, this high-reward potential comes with equally high risks. An ineffective strategy—or one that is poorly executed—can lead to significant financial losses. In some cases, traders may end up breaking even or losing more money than they initially invested.

The Reality of Day Trading

While day trading can be profitable, the reality is far more complex than the “get rich quick” image often marketed online. Profits depend heavily on the trader’s strategy, risk tolerance, market knowledge, and discipline. Even with the right approach, earnings from day trading may be relatively small and require consistent effort, patience, and persistence.

Successful day traders are typically those who thrive in fast-paced environments, make quick decisions under pressure, and follow well-structured entry and exit strategies. They rely on technical analysis, market trends, and disciplined risk management to navigate volatile market conditions.

High Risk, High Reward

Day trading involves substantial risk, including the potential for significant financial loss. The fast-moving nature of intraday trading requires constant attention and the ability to adapt quickly to changing market conditions.

Most financial advisors and economists caution that longer-term, more passive trading strategies generally offer more consistent and sustainable returns. Unlike day trading, long-term investing provides more flexibility and allows for compounding growth over time.

Additional Resources

CFI offers the Capital Markets & Securities Analyst (CMSA®) certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

• High-Frequency Trading (HFT)
• The Winning Mindset of a Trader
• News Trader
• Scalping (Day Trading Technique)
• Volume of Trade
• See all Career resources
• See all Capital Markets resources