Stocks and options are two common types of investments that people buy and sell in the hopes of making a profit. Stocks represent small shares of ownership in companies, while options are contracts that investors can sell to one another that give the buyer the option to buy a certain asset at a specified price at a future date. Day trading is the practice of buying and selling stocks, options or other assets within the same day.
Day Trading Basics
Day traders attempt to make profit on stocks, options and other assets by buying and selling frequently. Asset price can fluctuation significantly in a single day. For instance, a stock might go up and down by 1 percent of its value several times a day. Day traders attempt to buy assets when prices are low and then sell them days, hours or even minutes later when prices are higher. Unlike long-term investors who wait for investment values to trend upward over the course of years, day traders attempt to profit from short-term price fluctuations.
The primary benefit of day trading is that it has the potential to bring in large profits in very short periods of time. For instance, if a day trader managed to buy a stock at $40, sell it at $42, buy the stock again at $40 after a price drop and then sell it again at $42 after another price increase, his profit would be double that of the investment gains earned by someone who simply held shares of the stock during the same period.
The main drawback of day trading is that it is extremely risky because daily fluctuations in the stock market are impossible to accurately predict. The US Securities and Exchange Commission (SEC) states that day traders often suffer severe financial losses in their first months of day trading, and many day traders never progress to a point where they make a profit. Placing stock trades requires paying brokerage fees, either to a live stock broker or an online stock trading service. Trading very frequently will result in incurring more brokerage fees that can reduce profits and increase losses.
The SEC states that investors who make more than four day trades within five business days are labeled "pattern day traders." The US Financial Industry Regulatory Authority (FINRA) requires that pattern day traders must maintain a balance of $25,000 in an investment account at all times.