Day trading has exploded in popularity in recent years but what counts as a day trade and why does it matter?
According to the U.S. Securities and Exchange Commission (SEC), day traders rapidly buy, sell and, short-sell stocks throughout the day with the hope that the stocks will continue climbing or falling in value for the seconds or minutes they hold them, allowing them to lock in quick profits.
Day trading can be a great way to make money and achieve financial independence. You can day trade almost any market, though stocks, options, index futures, cryptocurrencies, and forex are most common.
But what is day trading? What counts as a day trade? Today, we’re going to tell you some of the most important things you need to know about day trading.
What is Day Trading?
Day trading refers to buying and selling stocks or financial instruments within a single trading day with the intention of making a profit.
When a day trader places a stock trade, they are looking to capitalize on price movements on the same day they place the trade and are not looking to hold a trade overnight.
For, example if you buy shares of GameStop ($GME) on Monday, you would have to sell it on the same day for it to be considered a day trade.
A closer look at day trading and the risks involved
Day traders rely on sentiment and stock charts to generate trading ideas instead of using fundamental data.
These traders often deal in a small number of stocks or securities – sometimes just one – and develop detailed knowledge of how those particular securities react to events. This enables them to forecast how the price would respond and thus trade profitably.
This type of speculation is very common in stock markets and foreign exchanges. But day traders can also trade exchange-traded funds (ETFs), cryptocurrencies, bonds, or commodities like precious metals or crude. They can also trade futures or options – different types of derivatives contracts.
Day trading is often portrayed in the media as being both a potentially highly rewarding and exciting endeavor. However, most beginner day traders lose money since this practice carries a great amount of risk and can cause one to quickly lose tens of thousands of dollars.
While most aspiring day traders are seeking financial security and freedom, one must adopt a trading strategy in order to be a successful trader.
Day traders have plenty of trading strategies at their disposal, but it’s important to point out that not every strategy works in every market cycle and may not be ideal for certain day trading styles.
If you don’t have a good trading strategy, you probably have no risk management and you are easily likely to join the 90% of day traders who blow up their accounts within a short time.
What is considered a day trade?
If you want to start day trading, you’ll definitely need to do what is considered a day trade and a pattern day trader. Here are a few examples to help you get into the day trading game.
Day Trading Examples
- Example#1
- On Monday morning, you buy 50 shares of stock Y
- Later on that same day, you sell 50 shares of stock Y
This is one day trade.
- Example#2
- On Monday morning, you buy 100 shares of stock Y
- Later on that same day, you sell 50 shares of stock Y
This is one day trade.
- Example#3
- On Monday morning, you buy 100 shares of stock Y
- On Tuesday morning, you buy another 100 shares of stock Y
- Later on that Tuesday, 50 shares of Y stock are sold
This is one day trade.
- Example#4
- On Tuesday morning, you buy 50 shares of stock Y
- Later that same day, you sell 25 shares of stock Y and before the closing bell you sell another 25 shares of stock Y
This counts as one day trade. Here, although you sold your 100 shares of Y in two different positions, it is still considered to be one day trade since you closed out one single opening position.
- Example#5
- On Thursday, you buy 100 shares of stock Y
- Later that day, you buy another 100 shares of stock Y
- Before the closing bell that day, you sell 200 shares of stock Y
This counts as two day trades. In this case, we have two opening positions closed by a single sell order. The first batch of 100 shares of stock Y was purchased and sold within the same day, and the second batch of 100 shares was also purchased and sold within the same day.
- Example#6
- On Wednesday, you put in 2 buy orders of 100 shares of stock Y
- Later that day, you sell 101 shares of stock Y
This also counts as two day trades. All 100 shares from the first opening position were purchased and sold within the same day. One share from the second opening transaction was purchased and sold within the same day.
While you only sold a single share from Order 2, buying and selling of that one share in on the same trading day is considered a day trade.
- Example#7
- On Tuesday, you make 3 orders: Buy 2 shares of Y, Buy 5 shares of Y, and Buy 50 shares of Y
- Later that same day, you sell 50 shares of stock Y
This is three day trades. In this case, we match up the closing position with the opening position during that day, starting with the earliest execution time.
This means you closed out all of opening order 1 and order 2, as well as part of opening order 3, thus triggering three day trades.
Pattern Day Trader
A pattern day trader basically refers to a speculator who makes day trading their full-time job.
According to the SEC, a pattern day trader is a speculator who executes four or more day trades in their margin account over a five business day period.
Stock market regulators implemented this rule in the wake of the dot-com bubble as a safety feature to help reduce the risk associated with day trading.
Pattern day traders are therefore subjected to more oversight and restrictions.
Once your account is flagged or classified as a pattern day trader, you may be restricted from day trading on a margin account if you don’t have at least $25,000 of cash or qualifying securities Furthermore, your account is likely to attract a 90-day freeze once PDT restrictions come into force.
Many day traders find this rule annoying and some immediately blame their stockbrokers. However, the pattern day trader rule is a regulation implemented by the SEC and the Financial Industry Regulatory Authority (FINRA).
Bottom Line
If you want to become a day trader, you will need to do some planning and research. Make sure you know what you are getting yourself into before you put one dollar in day trading.
There are numerous different day trading strategies, and there are online references and courses that can help you understand the process, risk/return, and methodology. Start by studying actual strategies and trades.
Finally, and most importantly, make sure to choose a good broker who will handle your day trading account.