Science Fair Project Encyclopedia
Day trading most commonly refers to the practise of either buying and then selling or selling and then buying a stock within the same day. This is done so that the shares bought do not have to be paid for, or the shares sold do not have to be delivered. A profit or loss is made on the difference between the purchase and sale price (day traders generally have no interest whatsoever in dividends). Day trading on currency markets is also common.
Day trading is not in itself essentially any more risky than any other trading activity but the ability to gear up on margin (i.e. using borrowed funds) can make it so: Substantial losses or gains can occur in a very short period of time (however, day traders typically do not keep a position open long enough to suffer badly from interest costs associated with margin). Many day traders use stop-loss orders to limit the potential loss if they judge the market wrongly. It should also be noted that, for the private individual, beginning day trading requires a great deal of capital, much of which will be lost while learning skills (or go to brokerage fees, which are quite high for day traders).
Day trading used to be the preserve of financial firms and professionals and some savvy private investors and speculators but in recent years has become notoriously common amongst casual traders taking advantage of new facilities offered via the Internet.
The motivations behind day trading are as various as they are for other forms of trading. It can be used to cover a temporary short or long position, to profit from a hunch or even from illegal insider information, or just for speculation or gambling.
In the USA, on February 27, 2001, the SEC approved rule changes for margin requirements for those who are considered "pattern day traders". Pattern day traders must have more than $25,000 in their margin trading account but are allowed to trade with twice the leverage of other stock traders.
Day traders typically look to two sources of financial gain. They are same day "swing trading" and "playing the spread". Swing trading (or position trading ) is where the trader holds the stock for a short time (usually more than a day) hoping their value will increase. An alternative is to short the stock, which is a way to profit on the stock decreasing in price, but which requires paying interest if one keeps the position open for a length of time.
Playing the spread involves buying at the Bid price and selling at the Ask price. The numerical difference between these two prices is known as the spread. The bigger the spread, the more inefficient the market for that particular stock, and the more potential for profit. This spread is the mechanism that large Wall Street firms use to make most of their money (as opposed to trade commissions) since the advent of online discount brokerages. To make the spread means to simply buy at the Bid price and sell at the Ask price. This procedure allows for profit even when the bid and ask don't move at all. This strategy has become less profitable (and popular) since stocks began trading in penny increments.
When the typical online investor places a market order to buy a stock, his broker submits this order to a market maker (MM), who then fulfills the order at the Ask price. In other words, the Ask price is the price the MM is asking for the stock. When the typical online investor places a market order to sell a stock, the broker submits the order to a MM and sells at the Bid price, i.e. what the MM is bidding for the stock.
Due to the liquidity of the modern market, orders are constantly flowing. Many times, a MM will buy a stock just to turn around and sell it to a particular broker. In fact, one of the primary purposes of the MM is to maintain liquidity in the market (among other things). Through this transaction, the MM will profit anywhere from a few cents to a whole dollar per share, in average circumstances. Over the course of a single day, a MM may fill orders for hundreds of thousands or millions of shares.
Day traders are able to capture some of the spread through buying access to Direct-Access Broker systems, rather than by trading through retail brokers. The average online investor uses a retail broker. (All of the brokerages that advertise $15, $10, or $5 commissions to the general public are retail brokers.) Through direct-access brokerage systems, day traders send their orders directly to the ECNs, instead of indirectly through brokers. ECNs put day traders on the same level as MMs.
Views of Day Traders
Day traders, through the use of modern technology and recent regulations changes (within the last 15 years), cut in on the MM's business action and take a piece of the pie for themselves. Some see this as causing frustration amongst investment banks, who are thought to villify day traders in the press. Day traders are for example seen as "bandits" or "gamblers" which is thought to discourage others from joining in on the activity.
On the other hand, some see the phenomenon of day traders as primarily created by the stock brokerage community, in order to get people to constantly trade more stocks, and to thereby pay more commisions. These critics see this as applying to business news and stations such as CNBC, which is seen as relevant primarily to day traders.
- E*Trade Financial Corp.
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