There is a trading strategy centered on actively buying and selling financial instruments within a particular day or multiple times over the course of a day to take advantage of small price movements. This is called day trading. Similar to other trading strategies, day traders earn from the spread or the difference between the buy and sell prices of a particular instrument.
The Pros: Advantages of Day Trading
Note that there is a difference between investing and trading. Investing centers on buy-and-hold strategies aimed at seeking larger returns over an extended period. On the other hand, trading involves buy-and-sell strategies that take advantage of rising and falling markets within a short period to take smaller albeit more frequent profits.
Day trading fundamentally inherits the general advantages of trading. However, when compared to other buy-and-sell strategies, it has more specific benefits. Note that a day trader opens and closes his or her trades before the end of the trading day.
The general principle is not to maintain positions overnight. The goal is to make a small but quicker profit on small fluctuations in the price of a particular instrument or asset. For example, if one buys a stock worth USD 330.00 and its prices at USD 334.00, then the trader can sell it for this new price and earn USD 4.00 within the trading day.
1. Possibility for Profitability
A key advantage of day trading is that it maximizes inefficiencies and volatility in the financial markets. Individuals who buy and sell a particular asset within a specific trading day can earn considerable gains from the minute price movements.
Limiting trading within a specific day also removes the risks that come from holding an asset overnight. Overnight positions have some uncertainties. However, in day trading, traders do not need to worry about events transpiring within the course of a night that can affect the value of a particular instrument or the overall health of the market the next day.
Shorter-duration and more frequent buy-and-sell allow returns on investment compound more quickly. Day traders can maximize the full profit-generating potential and benefits of compounding. Of course, this comes with an assumption that the entire endeavor is profitable.
2. Availability of Different Strategies
There are different strategies available to day traders that help them maximize short-term price movements. For example, scalping strategy involves buy-and-sell actions made within just a few minutes and even as short as a couple of seconds to make a profit from small price changes.
A news-based strategy involves actively looking for market information or other events from various sources that are likely to affect price movements. High-frequency trading or HFT strategy involves executing large numbers of transactions using automation platforms to earn from small price differences.
Other strategies include market timing, which involves an assumption that the steady increase in the prices of financial instruments will eventually reverse, as well as trend following or momentum trading, range-bound, and price action trading.
3. Trading Platform Accessibility
Before the arrival of the digital information age, individuals and institutions seeking to enter and access the financial markets need to transact with brokers either through face-to-face meetings or via phone calls. The process can be too taxing and time-consuming.
The availability of different platforms has made investing and trading more accessible and convenient. These online-enabled platforms have made day trading more advantageous because of the availability of a huge selection of instruments and assets such as stocks, currencies and cryptocurrencies, futures and contracts, and commodities, among others.
Furthermore, because these platforms are readily accessible using devices such as computers and even tablets and smartphones, day traders can transact wherever and whenever. Most of these platforms also provide market information, relevant tools, and best practices.
The Cons: Disadvantages of Day Trading
1. Involves Several Risks
Of course, it is important to note that trading is not a get-rich-quick scheme. There are several risks involved in buying and selling assets for a shorter period. In this particular case, one of the disadvantages of day trading is the unique risks associated with it.
Consider overnight positions as an example. While overnight events can affect the value of an asset or the health of the entire market, day traders also forgo the possible benefits that come from holding positions for an extended period. Some overnight positions can be profitable because overnight events can have a positive impact on the financial markets.
Some have criticized short-term buy-and-sell behaviors because it is simply akin to gambling. This is true to a certain extent. Note that day trading is a form of speculation. Day traders are essentially betting whether the markets will move up or down within a short time frame.
2. Requires Dedication and Expertise
Another disadvantage of day trading is that it requires a sophisticated level of monitoring market trends and events from multiple reliable sources. Hence, dedicating a considerable amount of time is necessary. It is not suitable for individuals with full-time jobs.
The capacity to read graphs through technical analysis is also a key skill that traders should possess. For day traders, technical analysis must be performed frequently and in a shorter duration. They also must arrive at a decision as quickly as possible. But learning technical analysis takes time. It can be too confusing or intimidating for novice traders.
It is also important to note that the United States Securities and Exchange Commission mentioned that a lot of day traders suffer from substantial financial losses in their first few months, and a lot of them never advance to profit-making status.
3. Advantages of Algorithm
Trading platforms can provide retail or individual day traders with tools for automation with a stop-loss functionality. Some of these platforms also provide so-called copy trading features to allow others to copy the trading patterns and behaviors of successful traders.
However, the built-in automation in commercially available platforms is not on par with the platforms used by institutional traders. The arrival of algorithmic trading puts individual traders at a disadvantage. Firms that can build technological capacities to operate machines can trade at a larger volume and as fast as milliseconds.
Individual traders are essentially competing against these machines. But the fact remains that they cannot outperform computers. Furthermore, building their own technological capabilities can be costly due to the advanced computing requirements.
A Note on the Advantages and Disadvantages of Day Trading
The advantages of day trading include the possibility of generating profits in a shorter duration, accessibility or ease of entry through the use of online-enabled trading platforms, and the availability of different strategies or techniques. However, there are disadvantages stemming from its inherent risks and limitations.
It is important to note that buying and selling financial instruments or assets within a short period can only be profitable if an individual will take it seriously. Doing so means learning different techniques, building capabilities, managing emotions, and dedicating time to actively trade while acquiring market-relevant information.
FURTHER READINGS AND REFERENCES
- Chague, F., De-Losso, R., and Giovannetti, B. 2019. “Day Trading for a Living?” SSRN Electronic Journal. DOI: 2139/ssrn.3423101
- Kuo, W-Y., and Lin, T-C. 2013. “Overconfident Individual Day Traders: Evidence From the Taiwan Futures Market.” Journal of Banking & Finance. 37(9): 3548-3561. DOI: 1016/j.jbankfin.2013.04.036
- S. Securities and Exchange Commission. 2005. “Day Trading: Your Dollar at Risk.” U.S. Securities and Exchange Commission. Available online
