In The Know: What Is Day Trading?

In many ways, day trading is the quintessential high-risk, high-reward approach to making money in financial markets. This article outlines the key role technology plays in day trading, what it takes to be successful as a day trader, and a comparison of day trading to investing. 

The technology behind modern Day Trading

While day trading has likely existed in one form or another since the inception of financial markets, the digitization of financial markets in the late 20th century has given rise to day trading as it is currently understood.

While practically all traders use electronic platforms, day traders aim to take advantage of such platforms’ most advanced capabilities to gain an edge. For example, near-real-time data feeds enable traders to analyse how markets move to make split-second decisions to buy and sell. Fast data processing speeds are particularly advantageous to high-frequency traders, who often seek to locate their computer servers in close proximity to those of equities exchanges to shave milliseconds off data transfer times.

Day traders also rely on electronic tools to identify chart patterns and formulate trading strategies, often with the help of algorithm-based software to automatically execute buy or sell orders. The sophistication of such automated trading systems continues to rise alongside the capabilities of artificial intelligence.

Day trading success Factors

While technology is the key enabler of day trading, a successful day trader’s most valuable asset is a cool head. The pressure of making quick decisions makes it particularly challenging to maintain discipline in the face of fear and greed, emotions with which a day trader must contend every day. Day trading is all about making a “quick buck,” and the fear of missing out on the next price move is day traders’ constant companion. A typical day trader will continuously refine trading systems or strategies, but sticking to them often proves to be his or her greatest psychological stumbling block.

Good day traders are also good risk managers. They aim to preserve capital by, for example, diversifying trades across multiple assets, avoiding allocations of all their funds to any single trade, and closing unsuccessful trades before they become more unsuccessful by setting what are called stop-loss orders.   

Day Trading vs. Investing

Despite involving the buying and selling of financial assets, most day trading strategies do not meet the generally accepted definition of an investment strategy, i.e., one that involves buying assets with the intention of holding them for (much) longer than a day. A typical investment strategy aims to build wealth gradually, e.g., through long-term price appreciation, dividends, or interest earned over time.

It’s worth noting that the most renowned individuals who have accumulated substantial wealth did not achieve their fortunes through day trading; they are typically known as investors. As Warren Buffett famously mentioned, “Our favourite holding period is forever.” While short-term trading might constitute one aspect of many wealthy individuals’ portfolio management strategies, it’s unlikely to be the sole component.