How Does Day Trading Work?

The news over the last few months has been dominated by an ongoing back and forth in the stock market. Fortunes have been gained and lost for many through day trading, for both professionals and what many call “retail investors” – your everyday person who doesn’t trade stocks for a living.

With so much attention and potential return, many people are left wondering how day trading actually works.

What is Day Trading?

It’s all in the name: day trading is the practice of buying and selling stocks or securities within a short timeframe. While the majority of people are interested in these securities for long-term investments (buying a home, retiring, tuition for your child), day traders will usually take these actions in a single day.

A day trader is the person who is sitting in front of their computer or on their phone monitoring the directions of the market. Typically, a day trader monitors business newsfeeds for indications of announcements that can cause a sizeable shift in a business’s stock. These announcements could include profit results, new economic reports, banks changing interest rates, corporate buyouts or, especially recently, endorsements by notable individuals like Elon Musk.

When it comes to making a move, day traders primarily consider two different options: will a stock go up or down?

Most day traders look for stocks that have the potential to go up. If a particular stock looks like it will rise in value or if there was recent news that indicates it might soon spike upwards, day traders will purchase a stock and sell it even a few hours later when it has increased in value. There is the risk, however, that the stock still decreases in value and a day trader can lose money.

Here’s an example to help:

1. Doug thinks that Company Co.’s stock is going to fall soon. Doug decides to short 100 shares of the stock, which are currently valued at $5 per share, borrowing them from whatever brokerage he is using. He now has a contract to pay back those 100 shares by a certain date.
2. Immediately, Doug sells those 100 Company Co. shares and now has $500.
3. Doug waits (sometimes for a little bit, sometimes for a while) and hopes the stock value falls. Let’s say it does, with each share now worth $3.
4. Doug buys back 100 shares of Company Co. stock, costing him $300, and returns those shares to the brokerage. In the end, he pockets the $200 difference, not including any trading fees incurred throughout the process.

Shorting is more complicated than that, but this example highlights the fundamentals to help you understand it better. If the stock of Company Co. had actually gone up in value, Doug would have to buy the 100 shares back at whatever price available before the contract expired with the brokerage, potentially resulting in a loss that doesn’t really have a limit.

Because of companies like Wealthsimple and Robinhood, trading is accessible to most people and easier than ever. Still, anyone thinking about day trading needs to consider the risks associated with it.

The Risks of Day Trading

Like with most things, day trading comes with some innate risks that you should be aware of. This is especially true as day trading can have a tangible impact on your financial health.

day-to-day volatility in stocks can quickly result in losses just as substantial if not worse than potential gains.

3.You aren’t a professional. This might sound harsh, but retail investors are more prone to invest based off emotions, feelings or advice from their well-intentioned family member who knows very little more than they do. This results in more losses or even holding on to a stock long after you should have sold it and taken the smaller loss.

4.It requires time and tools. Professional day traders have access to software, analytical tools, deep pockets and credit, teams of analysts and years of experience to inform their trades. It absorbs most waking moments of their lives and has had notable impacts on physical and mental health. True day trading requires investment, commitment and sacrifice that most people really shouldn’t put into it.

Now that’s not to say that you can’t dabble in day trading or make a small profit off of it. Many people enjoy trading their own stocks and are successful in finding better returns than putting their money in portfolios or with wealth managers. Just keep these risks in mind and understand that quitting your day job to focus on day trading has a lot of risk associated with it.

How Do You Get Started in Day Trading?

If you want to dabble in day trading, here are some steps to get started.

1.Be honest with yourself. A good rule of thumb with investing is to not put in what you can’t afford to lose. Are you in a financially stable place to potentially lose money?

2.Start with a practice account. Most brokerages and investing apps have the ability to try your hand with a practice investing account. This gives you some fake money to “invest” in stocks, showing you how your investments play out day over day without risking your real money. This can help you understand the real impact of your choices without risking money. Questrade is one company that offers a practice account.

3.Open a self-directed investment account. There are countless options out there for your investment account. All big banks have their own platform that can be used for day trading. Other options include Wealthsimple, Questrade, Robinhood, Betterment and so on. Be sure to do your research to understand which platform is best for you.

The opinions expressed in this blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about day trading and the financial industry. The views reflected in the commentary are subject to change at any time without notice.