Day trading is a controversial aspect of the stock trading world. The Securities and Exchange Commission (SEC) warns against using daytrading as a way of making a daily living and cautions against getting involved in the practice.
But what is day trading and why should we be concerned and cautious before we become involved in it? Day trading is the practice of rapidly buying and selling stock throughout the day in the hopes of profiting from stock price as they increase and decrease in the market in that specific day.
A true day trader does have a game plan. The day trader look at a various criteria when determining whether a stock is suitable for day trading. First, the stock must have a high liquidity. This means that the stock in question has a large volume of buyers and sellers. The liquidity allows day traders to quickly acquire and then sell a stock. Liquidity is based on the volume of transactions on the market, the number of outstanding shares, the total number of shareholders and the number of market makers. Not all stocks on the NASDAQ and New York Stock Exchange (NYSE) have a high degree of liquidity.
A day trader also looks at volume by itself, in addition to using it as criteria for liquidity. To be eligible for day trading, a stock should trade at least a half a million shares a day. Stocks with a least half a million trades a day will allow the day trader to acquire or sell a large amount of stock without greatly affecting the price of the stock. Volatility is another factor in evaluating a stock for day trading. Volatility of a stock refers to the actual or expected price movement. This movement is up or down over a short period of time. Day traders look at the volatility of stocks over an individual day. Stocks that change price frequently over one trading day are ideal candidates for day trading. A fluctuation of at least $2.00 per day is recommended.
Finally, a day trader evaluates the price transparency of stock. This term refers to the ability to gather information on the order flow of a stock. Also called market depth, price transparency helps the day trader determine just how much money there is to be made on a certain stock. The Nasdaq II quote system offers information on all bids. Day traders who arrange to access the NASDAQ level II quote screens can assess the strength or weakness of a stock and determine its movement in price.
While day trading is completely legal and entirely ethical it is definatly a highly risky business. Day traders usually buy on borrowed money with the hope that they will obtain higher profits through their acquisitions and sales. People who are deemed “pattern day traders” by the NASDAQ and NYSE must have at least $25,000 in their accounts and can only trade in margin accounts. Margin accounts are brokerage accounts in which the broker lends the investor cash to purchase securities. If the value of the stock drops significantly, the investor is required to deposit more cash to cover the margin or sell the stock.
The SEC warns against day trading and has taken many steps to inform people of the associated risks.
The first few months a vast majority of day traders suffer massive financial losses and only a few make it through to become profit-making day traders. For this reason, day traders should only invest money that they can afford to lose. They should never use money for necessities such as living expenses, retirement accounts or second mortgages.
Keep in mind that most day traders do not own stocks for longer than a few minutes at most. Stocks are never kept overnight because of extreme risk of prices changing to the detriment of the trader. Day tradering is not an investment, but rather a speculation on the movement in price of a stock throughout the day.
