"Day Trading" refers to opening and closing positions within the same day. The markets do not fluctuate much over the course of a given day relative to their movements over longer periods of time. Therefore, day traders will look to use as much leverage as possible to magnify their exposure to those market moves that they can find. Most day traders treat market speculation as their full- or part-time job. They see trading through the lens of a daily employment regiment, punching in at the beginning of the day and closing out any positions at the end.

Day Trader's Gift to the Markets

Day traders benefit the market by offering liquidity and efficiency. Markets operate best when there are active buyers and sellers at all times. With numerous day traders operating in the market for Euros and Dollars for example, a bank knows that when you exchange your travel money they can easily and instantaneously find a counter party to your exchange. In terms of efficiency, any trader who has looked for any small arbitrage opportunities knows that few if any easily exist in markets, since day traders will take advantage of them the moment they appear.

A Few Brief Characteristics of Professional Day Traders and Their Strategies

Understanding of Market Fundamentals

Every professional day trader will tell you they have a good understanding of what drives markets. Where that expertise lies, though, may vary from one day trader to another. Some develop bias based on underlying economic fundamentals, like the direction of trade & capital flows or central bank policy. Other professional traders say they have developed a sense for turning points in market sentiment, knowing precisely how to differentiate a true reversal from a fake-out. This characteristic can be summed up simply as market expertise. Traders who do not possess such qualities are often left guessing as market conditions shift, resulting in heavy losses.

Professional traders surveyed for this article suggest the best way newcomers to the market can develop the expertise needed to be a successful day trader is through practice. Demo accounts, mini accounts and e-minis all allow practice with small amounts of start-up capital.

Sufficient Capital

Although leveraged accounts allow day traders to open large positions with small amounts of capital, unsuccessful day trading strategies are too often the result not having enough funds in an account to weather downturns. Successful day traders know that most positions will not become profitable the moment they are opened. This makes strategic position sizing an absolute essential, as it determines one's staying power in the market and can often mean the difference between a winning trade and a losing one.

Traders that increase the amount of idle capital available to cushion their positions either through a large initial balance or smaller position sizes lower the risk of margin calls. An over-leveraged account may only be able to withstand a small disadvantageous price move before a margin call locks in a floating loss. By reducing the position size a day trading strategy requires, the trader reduces his/her exposure to the market and is able to manage their positions more effectively.

Strategies

Day traders first look at market conditions, searching for high liquidity & high volatility. Markets with higher liquidity usually have lower spreads, slippage and other costs. For example EURUSD, the most widely traded currency pair, has far lower spreads than less liquid pairs like the AUDNZD or GBPJPY. The lower the liquidity, the wider the spread and the more pips a day trader will need to overcome in order to have a profitable trade.

Volatility refers to the average range a currency pair tends to trade in a day. Compare GBPUSD to EURGBP. Because the Pound Dollar tends to trade in wider range it offers more opportunity for day traders to grab hold of market moves. Trading EURGBP on the other hand can be one of the most painful experiences imaginable for a day trader, since is pair tends to stick to a tight daily range and offers little opportunity for intra-day speculation.

Entry Strategies

Short term Technical Analysis - Like most other speculators, day traders turn to technical analysis for entry strategies. To lists them all or go into any great detail would be beyond the scope of this article. A simple example could be to watch how a currency pair reacts at a key support or resistance level and enter a trade should it break through or reverse at that price. Day traders have a particular advantage here, as they tend to watch the market in real time and wait for the most ideal entry points using the shortest term signals.

Candlestick Analysis - Candlestick formations are often used to suggest a turning point or the continuation of a trend in price action. Where the typical candlestick analyst will follow daily charts, a day trader has the liberty to apply the same techniques to shorter terms frames, preferring four-hour dealer charts or hourlies.
Bearish Reversal Candlestick Gallery | Bullish Reversal Candlestick Gallery | Continuations Candlestick Gallery

Real-time News - While underlying fundamentals move currencies in the long run, intraday traders seek to capitalize on jolts of volatility caused by new releases of crucial economic data. When data announcements do not meet with market expectations, the market will become extremely active as traders seek to reposition themselves in light of the new development.

Many day traders will enter the market trying to capture spikes in price action around news announcements as they are released. While they may find the quality of execution lacking during these times because of low liquidity, volatility is usually at its peak.

Speculative positioning - Traders will often look at what the majority of speculative market participants are doing as an added layer to their analysis. The underlying logic suggests that when market positioning is greatly skewed in favor of or against a given financial instrument, it can be indicative of imminent reversal. For example, if the majority of speculative positions in a given asset are long, any positive development for that asset will be largely contained as there are relatively few traders left who are not buyers already. Conversely, if a negative development occurs, this may signal a massive a reversal as most traders find themselves on the wrong side of the market. This logic would apply in reverse if positioning was net short.

It is not possible to get access to precise positioning metrics for the FX market as it is in equities or futures. This is because there is no central exchange that aggregates information on who is long versus short, and by how much. However, FX traders will look at information such as the Commitment of Traders (COT) report which reflects positioning in currency futures as a proxy for the overall market's posture.

Exit - Price Target Strategies

Scalping involves getting out of positions the moment they are slightly profitable. Scalpers tend to see a high percentage of their trades profitable, easily a hundred in a row. A scalper's worst fear is when the market turns against a position before they can get out, resulting in large losses. For scalpers, one bad trade can offset the earnings from a hundred small profits.

Fading involves trading against over-exaggerated price moves. Following news announcements, price often spikes in one direction. As the initial volatility subsides, however, the price tends to revert back to its normal trading range. In terms of market psychology, existing profitable positions are often the first to exist, as they may be scared out of the market. Day traders will exit as the violent whipsaws in price activity give way to calmer trading, reducing the number of trading opportunities available in the market.

Following Momentum - many day traders enter positions when they think the pair will continue for a time in one direction. Momentum traders watch the strength of the trend while they are in the position, and exit when the move appears to have played out. The signal to close might be a reversal candlestick pattern, or the price reaching a key level of technical support or resistance

Stop-loss Strategies

Since most day traders follow their position from open to close in real time many do not feel the need to use stops. Many traders also don't like to tip their hand and show market makers where their stops are placed, for fear of stop hunting. Such traders will typically use a 'mental stop,' or a wide stop order with a trail.

  • Mental Stop Loss - With mental stop losses, traders exit their position when the original entry rationale is violated. Should the market make an unacceptable move the trader exists their position.


  • Trailing stop - Day traders will modify a generously spaced stop-loss order with a trailing stop condition. The Trail will move a stop order up as the market advances in the postion's favor to lock in profits. Trails offer the security of a physical stop, while leaving sufficient room to let a position develop over time.


  • Stop loss - These are orders to exit a position at a specific price. The distance a stop loss is placed from the entry price reflects the most a trader is willing to lose on a given transaction. Despite the worries noted above, many day traders will still use an old fashion physical stop order. However, most will take the precaution of placing it just beyond key support or resistance levels that might reasonably be hit.

Max Daily Loss.

Many market makers offer a Day P/L section of their trading platform specifically for day traders. Day P/L quotes the profits and losses incurred by the trader just during that trading day - irrespective of the previous day's positions.

A trader who establishes for him/her self a maximum daily loss and reaches that level will stop trading. Many day traders also have a max gain. This protects a trader from succumbing to overconfidence, which invariably leads to poorly thought-out trade decisions.

Overall Performance and Risks of Day Trading

Day traders need to know that following a strategy closely is often very hard. There are numerous behavior economic studies that suggest people are very protective of easy profits, (getting out of profitable positions early), and fretful to commit to unrealized losses (keeping small floating losses open long enough to become large closed losses).

Any reasonably seasoned day trader with can relate to this experience: just as your strategy tells you to cut you losses, you realize the desire to simply run to the restroom for a bit and see if it comes back your way. Naturally, this usually just serves to exaggerate one's losses even further.

To that effect, a day trader's performance is best tracked by a combination of overall profitability and how well that trader is able to stick to their strategy. While specific approaches will invariably evolve as market dynamics shift, the hallmark of a successful day trader is he/she can attribute their overall profitability a clear and reproducible trading strategy, and not good or bad luck.