Day trading can be lucrative, but it can also go all shades of wrong. Like any stock picking, it’s risky. The kind of risky where you should only be doing it with money you’re prepared to lose. Still curious to learn more about day trading? We’ve got you covered.
What is day trading?
In simple terms, day trading involves buying and selling stocks on the same day, based on price fluctuations. It’s “buy low, sell high” on energy drinks with a deadline. Day traders focus on liquid investments that fluctuate quickly. Buys are made in volume, and then sold as the price hopefully increases through the day. It’s about timing the market, and that requires experience, knowledge, a lot of luck and the understanding that it still may not work out. Day traders need nerves of steel. Day trading is a high-risk strategy and one that’s not suited to most investors. It’s wise to consult with a financial advisor to discuss whether it’s a strategy for you (spoiler alert: the answer will probably be no). While your investments could increase in value, they could also drop significantly. Many day traders have lost everything because they misread the market. Still not turned off? Alright then…
How to start day trading
If you want to start day trading, you’ll probably need to do some research and planning. Here is some information to help you get into the day trading game.
1. Learn the market
Before you invest one dollar in day trading, make sure you understand what you are (literally) signing up for. It’s not enough to have a general understanding of the stock market; you need to understand how world events can affect volatility, how trades work, how different industries respond and how to anticipate fluctuations. Many day traders specialize in a specific industry.
2. Develop a strategy
There are many different day trading strategies, and there are courses and online references that can help you understand the process, methodology and risk/return. Start by studying actual trades and strategies. You might find a contrarian strategy or maybe trend following. Just know that they’re all based on speculation. You can find many free resources online that allow you to watch live trades, study stock charts and trends, and read financial analysis. How would you handle the trade? When would you sell, how much are you willing to risk, how would you make out if you employed your strategy?
3. Set up a demo account
Before you start risking real capital, set up a demo account to learn the ropes. You can buy and sell in real time, but in a safe space as you learn more about reading the market, the trends and fluctuations, how much to risk and at what point. Practice, practice, practice. You can develop, hone and perfect your strategy in a demo environment that won’t cost you your house if you get it wrong. Keep testing your strategy until you are confident.
4. Set goals and know your limits
It takes time to learn day trading. Especially when you start trading with real capital. You need to trade while markets are open, which is during normal business hours. Missing a sell because you didn’t execute the transaction before the exchange closed could be a costly lesson if the stock/future/currency fluctuates over night. Most companies will not understand that you need to leave a meeting to execute a trade. Don’t give up your day job until your profits exceed your take home pay consistently. Wealthsimple Trade offers you a commission-free way to buy and sell stocks and ETFs, and could save you tons of money as you hone your skills.
Especially at the beginning, you need to set a realistic limit on the money you are willing to spend on day trading. If it’s money you cannot afford to lose, then day trading may not be for you. No strategy or investment methodology will protect you from a stock market implosion due to an unforeseen event. Just like gambling, the lure of the win can be intoxicating, but it can also be a siren song to bankruptcy and foreclosure. Many’s the person who tried to trade their way out of a hole, only to panic, stop reading the market (or find they were unable to) and find themselves in a much bigger hole.
5. Find out the tax implications
Talk to your financial advisor, accountant or a tax specialist to find out how day trading profits are treated at tax time, so you do not have a nasty tax bill that eats up all your gains. In many countries, the tax treatment may depend on whether you are seen as an “investor” or a “trader” who does this for a living. There may be rules around the length of time between trades, how capital gains and losses are treated and what qualifies you to be a professional day trader. You should consult a tax professional who can assist you in determining where your activities fit, and what rates apply.
6. Choose a broker
Any day trading activity is conducted through an investment platform, so this is one of the most important steps you can take before starting to day trade. Not only will this broker be in charge of your account, but you will be executing your trades through their trading platform, and when timing matters, it needs to be reliable. Reputation and expertise matter, so take the time to find the right fit for you and your goals.
How to choose a broker for day trading
One of the most important decisions you will have to make before you start day trading is choosing the broker who will handle your account. Here are some things to keep in mind:
Decide what you will be trading
Different brokers have different areas of expertise and a FOREX broker may not deal in stocks, or vice versa. Find a broker who deals in the area you want to specialize in.
Talk to other day traders to see what platform they recommend. Like any industry, reputation matters, but never more so than when it’s your money on the line. Check online reviews, discussion boards and social media content, ask your colleague for recommendations, and take the time to examine their website.
Ask for references… and CHECK them
Check the credentials of the trading platform with their regulatory agency to see if they have had any actions or complaints against them. How long have they been in business, how many employees do they have, and how long have they been handling day trading accounts? The last thing you need as a new day trader is a broker who doesn’t abide by the rules.
Ask about fees and commissions
Nothing can eat away a profit faster than commissions and admin fees. Large volume trades could have thousands of dollars in commission fees.
Ask about technology
Day trading relies on quick actions and reactions. Is your broker’s trading platform up to the challenge? What trading platform do they use and what kinds of accounts do they deal with? Since day trading relies on timing the market, does the broker offer a real-time data-feed so you can track your activity easily? How quickly do they respond to trade requests?
How many day trading accounts do they have, what kind of volume of trade do they typically handle and what kinds of safeguards and cyber-security measures do they have in place?
Find out if they offer customer service
What kinds of tools and analysis do they provide to their clients? Are they strictly a clearing house for your activities or are they going to provide support to help you make the most of your trading activity? What is the process and what is their complaint resolution practice? What happens if their system crashes mid-trade and it costs you a fortune? If there is a keying error, what does the contract say about liability? People never read that section of a contract until it’s too late. (make sure you read the whole contract and ask questions to ensure you understand what you are signing.)
How much money do you need to start day trading?
Day trading requires capital, and many day traders borrow funds to make the purchases, a practice known as “leveraging” or trading “on margin.” They make a series of trades to maximize their return, counting on selling at a profit that will cover the cost of the loan and still make a profit. If they misjudge the movement of the market, they could lose their profit and be on the hook for the loan. Professional day traders work with risk capital, investing only what they can afford to lose (often no more than 1% of their account balance.) Rookie day traders often learn this lesson the hard way, and some have lost everything trying to time a market they didn’t understand.
Day traders also need access to ready capital to react quickly to the changes in the market throughout the trading day. Different types of trading require different minimums.
If you are interested in trading in foreign currencies (FOREX), there is no legal minimum for a FOREX account. However, currency is traded in lots, and the minimum trading lot is 1000 units of whatever foreign currency lot you are interested in. You need enough in your account to purchase the minimum, without wiping out your account in the process. Like stocks, currencies can fluctuate wildly and are sensitive to world events. A knowledge of world politics and international trade is helpful if you want to get into FOREX trading.
If you want to be a day trader in stocks, you need a minimum of $25,000 in the U.S. If you day trade in Canada, there is no prescribed minimum, but your broker may require you to adhere to the $25K rule if you are buying securities that settle in the U.S.
If you want to day trade futures contracts, most brokers require a minimum account balance of $1000, but $8000-$10,000 is recommended by many providers. Most day traders won’t risk more than 1% of the value of their account on any one trade, and $1000 will not give you enough capital to make the trade worth your while.
Alternatives to day trading
So maybe at the end of the day, there’s too much risk involved in day trading. There are other activities that you can do that can increase your profits without risking your house! Did you know, for example, that robo-advisors create a personalized investment portfolio for you so that you hardly have to lift a finger.
One of the less risky strategies that still allows you to invest in the stock market is to buy stocks and hold them for a longer period of time. As you learn more about how the stock market rises and falls, you will gain knowledge that could help you day trade down the road. In the meantime, you could be increasing the value of your assets.
You can also follow the market passively by investing in index mutual funds or Exchange Traded Funds with an automated investment platform. They generally seek to match the performance and return of a particular stock market index. You set it and forget it, and the algorithms do the rest, rebalancing your portfolio to stay within your investment direction and level of risk comfort you have.
Wealthsimple Trade is the no jargon, no paperwork way to start commission free trading. We make it easy to buy and sell thousands of stocks and ETFs from the comfort of our easy to use app — get started here.