Getting into day trading shouldn’t be a decision made on a whim.
It takes time and dedication to learn the intricacies of this fast pace world, but with the right information and careful planning you can put yourself in a position to earn a great living on just a few hours of trading a day.
Before we dive into our day trading guide you must first understand what day trading is and what it is not.
What is Day Trading?
Day trading is the opening and closing of a trade within the same day. That means if you open a new trade at 10AM and close it by 2PM, that’s a day trade. Many traders only day trade, others implement it only when they see opportunity, and others shun it completely.
A day trader doesn’t just pick any stock and try to trade it. There has to be some reason to trade it, and that reason differs from trader to trader. Some of the different strategies include:
The thing to remember here is there is no holy grail strategy to get rich quick. It all takes time and practice to become successful at this potentially lucrative career.
And that brings me to my next point.
Day trading should not be viewed as a way to get rich quick. Most successful day traders focus on base hits, or taking small winners consistently in order to bring in income. Sure, big winners will come but focusing on just hitting every trade out of the park will lead you down a path to a short trading career.
How to Day Trade a Small Account
What You Need to Day Trade For a Living
Day Trading Broker
Your broker is one of the bigger decisions you will make. This is where all your money will be and you will rely on them to provide fast executions at a reasonable price. There are several types of stock brokers out there, and most tend to serve a specific niche. For example, Vanguard serves passive investors, Tastytrade serves options traders, and Lightspeed serves day traders.
For day trading these are our favorite brokers:
Day traders require certain things from their brokers. The most important thing is speed of execution. A few seconds can be the difference between catching and missing a breakout. For this reason, serious day traders need a broker who provides direct market access (DMA).
You might be asking: ‘ don’t all brokers offer direct access to the market?’ The answer is no. Most online brokers act as a middleman between the market and your order. They route the order to the market on your behalf, often combining your order with other clients’ orders, and giving priority to certain routes over others when they sell your order flow .
To cut out the middleman, you need a broker that grants you DMA. This way, if there’s a bid or ask that you’d like to trade with, you can simply take that liquidity instantly, rather than hoping the stock trades at your price long enough for your broker to fulfill the order.
One example of a broker who grants direct market access is Lightspeed Trading.
Day traders trade so often that commissions can be the difference between a profitable month for some. Typically, when it comes to day trading brokers, there are two pricing structures: per-share and per-trade. The choice is dependent on your position sizing. The smaller size you take, the more a per-share structure makes sense, and vice versa.
The per-share structure is popular with day trading brokers and proprietary trading firms . Typical per-share rates offered to the least capitalized retail traders are $0.005 per-share traded. Some firms require a $5.00 minimum, which defeats the purpose of the structure for an undercapitalized trader.
This is the most common commission structure in the industry. You simply pay a fee (most often around $5.00) per trade you make. When you reach a certain average position size, a $5 fee per trade becomes almost inconsequential.
Quick Note: It’s important to understand that just because a broker has cheaper commissions doesn’t automatically make them a better option. Some brokers get paid for directing their order flow to certain market makers which can take longer and result in worse fill prices. That’s why it’s important to make sure they have direct market access like we mentioned above.
Day traders generally take very small moves out of the market. Most make money through their size and repeated efforts, rather than catching huge moves. For this reason, you need to be reasonably capitalized to make a considerable salary from day trading.
A smart way to determine how much capital you need to get the income you want is to forecast your annual return. You can reverse engineer by looking at your average return from your current trades (if any), and multiply it by your average trade frequency (quantity of trades you make per year).
Then divide that number by your account size. Of course, this won’t be the most accurate forecast, but it provides you context.
There’s a distinct difference between a stock scanner and a stock screener. A stock scanner is constantly scanning the market and streaming real-time results. A stock screener simply searches the market for criteria which provides you with a static list of stocks.
A good stock scanner is necessary for most day traders, especially those who trade on very short time-frames. Most scanners can scan on time-frames as small as ticks, and move out as far as weeks, all while updating results in real-time.
An example of a stock scanner that fulfills the above criteria is Trade-Ideas.
What Should Have Before You Start Day Trading
We’ve gone over the things you reasonably need to day trade: a trading platform, stock scanner, and possibly a news feed. Having these things doesn’t make you a trader though. If you want to stand a chance at not blowing up your account, there are a few other things every budding day trader should have. Ignore these at your own risk.
What a surprise that we’re recommending trading education! It might seem salesy to include, but day trading is an exceedingly difficult skill to become competent at, let alone master.
Here are just a few of the topics that you will need to understand:
- Technical analysis – That’s trends, channels, and pattern recognition.
- Reading the tape – That’s noticing held bids and offers, unusual prints, and imbalances.
- Trade execution – That’s setting stop losses, scaling in, and getting in the trade when the best opportunity is presented.
- Trading psychology – That’s learning to think in probabilities, outcome independence, and dealing with life-changing losses.
- Position sizing and risk management
Whether you learn this stuff from a course, books, dozens of articles, or a mentor, you have to develop these skills to stand a fighting chance in the day trading world. Few, if any, have been able to teach themselves solely through trading the markets.
You may have taken a few quality trading courses, read a book or two, and have been watching our daily trading breakdowns and feel like you’re ready to trade. You’re probably not ready. Intellectually knowing about trading and being able to react to opportunities and effectively execute them are two different things.
This was definitely the case for me. Before day trading live, I educated myself so much until I finally felt like I was ready to trade live. When the market opened and I began scanning the market for opportunities, I felt more wide-eyed than Jordan Belfort on his first day on Wall Street.
It’s street smarts vs. book smarts. They’re both important.
This is where trading simulators and paper trading come in. These pieces of software allow you to trade with either historical or real-time market data and practice trading.
Excuse the shameless self promo but, we think that the Warrior Trading Paper Simulator tackles this issue quite well. Trade against real-time data with real level 2 and time & sales with hot-key functionality.
System or Methodology
It’s important to have a specific setup, trading system, or methodology that you’re comfortable with when you start trading. It allows you to develop a competency at something, rather than trying to find opportunities for several setups at once, never really getting good at any one setup.
Whether it’s a simple trading setup like the trend pullback , or a more fleshed out trading system like Toby Crabel’s opening range breakout system, sticking to one thing at the beginning will allow you to reach profitability the quickest.
You can always learn more down the road if the setup/system you choose isn’t ideal for you. The important thing is consistently sticking to one thing at the beginning.
How to Start Day Trading
You need to understand basic day trading terminology & concepts to build your foundation. You can follow me on Youtube to get free education! Join the community of thousands of followers on YouTube and begin studying the free content we post on a daily basis. This is the beginning of your education. You need to study the markets, analyze charts, and learn the strategies professional traders are using every day.
A day trader is two things, a hunter of volatility and a manager of risk. The act of day trading is simply buying shares of a stock with the intention of selling those shares for a profit within minutes or hours. In order to profit in such a short window of time day traders will typically look for volatile stocks.
This often means trading shares of companies that have just released news, reported earnings, or have another fundamental catalyst that is resulting in above average retail interest. The type of stocks a day trader will focus on are typically much different from what a long term investor would look for.
Day traders acknowledge the high levels of risk associated with trading volatile markets and they mitigate those risks by holding positions for very short periods of time.
Day Trading Rules
You Need $25,000 (Pattern Day Trader Rule)
The pattern day trader rule was designated by FINRA in 2001, after many retail traders lost their shirts day trading during the dotcom bubble. The rule essentially states that traders with less than $25,000 in their brokerage account cannot make more than three day trades in a five-day period.
In other words, if you have a $5,000 account, you can only make three day trades (open and close inside a market session) within a rolling five-day period. Most brokers will not allow you to make the fourth, but if you do, you will be labeled a pattern day trader and have your brokerage account restricted for 90 days.
Margin accounts are most affected by this restriction, although cash accounts are prohibited from using unsettled funds to purchase securities. Once you have $25,000 in equity in your account, these restrictions no longer apply to you.
Besides the PDT, there are few regulations placed upon day traders in specific.
There are a couple ways around the PDT like opening an account at a broker who is offshore or outside the regulations of the United States. Some that you can consider are TradeZero.
How Much Do You Need for Day Trading?
The amount of capital you need depends on if you want to make day trading your full-time income. If you’d like to day trade as a hobby, or for side income, the advent of commission-free brokers make it so that you can day trade with virtually any amount of capital, even if only three times per week.
With that said, we’ll focus the rest of the section on those who are trying to make day trading their main source of income. We have to start with your expected returns. This is the hardest part to project. So unless you have a thoroughly back tested strategy, we’ll have to estimate your returns.
The first big assumption we have to make is that you’re a profitable day trader in the first place, which is a lofty assumption. Trading blog Vantage Point did an informal study of this throughout his long trading career and found that 3.5% to 4.5% of traders reach relative success. Even assuming marginal profitability can be dangerous, but assumptions are the nature of forecasting.
Barber and Odean performed a study on the rate of return for individual investors making speculative trades and found that they underperform the S&P over time. So let’s make a quick assumption that without a rigorous trading education, you’ll fall right in the middle of that average, and capture roughly half of the S&P’s annual return in your day trading account, which is roughly 5%.
On a $100,000 account, that’s about $5,000 per year.
On a $1,000,000, that’s about $50,000 per year.
Do you see the importance of gaining an edge over the rest of day traders?
Day Trading with Cash vs. Margin
There are some distinct differences between a cash and margin account when it comes to day trading.
- You can day trade as much as you want as long as your funds are settled (takes two days from trade date to settle, click the cash account link for more info)
- You can only trade with the amount of cash you have in the account
- Placing day trades with unsettled funds could result in the account being suspended
- Can only place 3 day trades in a 5 business day period if you are under $25k
- You have 2x the buying power for accounts under $25k and 4x the buying power for accounts over $25k
- You can buy more shares than cash in your account since you are granted leverage
- You can lose more than you have in your account since you’re trading on borrowed funds
As you can see there are some major differences but most day traders trade on margin due to ability to leverage their account and trade bigger sizes. Just take note of the risks involved and manage your trades appropriately!
Simple Day Trading Strategy for Beginners
We talked earlier about sticking to one simple pattern when you’re starting out as a day trader. We’re of the opinion that the bull flag pattern is the ideal pattern to learn first. It’s a simple consolidation pattern that is easy to recognize and trade. To put it simply, you’re buying a pullback within an existing uptrend in a stock.
The first step is finding a stock that is surging on high relative volume, preferably one that is already in a longer term uptrend. So, if you’re looking for a bull flag with a 5-minute chart, it’s much better if the daily chart is showing an uptrend, you’re sailing with the wind. The next step is to wait for the stock to consolidate. You want the consolidation to be much lower volume than the upward move.
You then want to buy the stock when it breaks above the consolidation pattern with higher volume, using a volume moving average to identify high volume. Your stop should be below the bottom of the consolidation pattern. Some traders like to give the stock some room to move a bit and place their stops 0.5 to 1 ATR below the consolidation pattern, to account for market noise.
These are the types of trades that you can let run if they continue to work, without a defined profit target. However, it’s important to make sure you’re taking setups with at least a 2:1 reward/risk ratio. That means your minimum profit should be twice your stop loss.
All Day Trading Strategies Requires Risk Management
Imagine a trader who has just taken 9 successful trades. In each trade there was a $50 risk and $100 profit potential. This means each trade had the potential to double the risk which is a great 2:1 profit loss ratio. The first 9 successful trades produce $900 in profit.
On the 10th trade, when the position is down $50, instead of except the loss the untrained trader purchases more shares at a lower price to reduce his cost basis. Once he is down $100, he continues to hold and is unsure of whether to hold or sell. The trader finally takes the loss when he is down $1,000.
This is an example of a trader who has a 90% success rate but is still a losing trader because he failed to manage his risk. I can’t tell you how many times I’ve seen this happen. It’s more common than you’d think.
So many beginners fall into this habit of having many small winners then letting one huge loss wipe out all their progress. It’s a demoralizing experience, and it’s one that I’m very familiar with! We will discuss in detail how to identify stocks and find good trade opportunities, but first we will focus on developing your understanding of risk management.
Every Day Trade Needs a Max Loss (Cap your Losses)
Over my years as a trader and as a trading coach I have worked with thousands of students. The majority of those students experienced a devastating loss at some point due to an avoidable mistake. It’s easy to understand how a trader can fall into the position of a margin call (a debt to your broker).
The money to trade on margin is easily available and the allure of quick profits can lead both new and seasoned traders to ignore commonly accepted rules of risk management.
The 10% of traders who consistently profit from the market share one common skill. They cap their losses. They accept that each trade has a pre-determined level of risk and the adhere to the rules they set for that trade. This is part of a well defined trading strategy.
It’s common for an untrained trader to adjust their risk parameters mid-trade to accommodate a losing position. If for instance they said the stop is $50, when they are down $60 they said they’ll hold just a few more minutes. Before you know it, they are looking at an $80-100 loss and they are wondering how it happened.
This article should provide you with a good introduction to the world of day trading. But, it’s just that: an introduction. Don’t expect to read this and go take money out of the markets on a daily basis.
You won’t learn day trading in a day, or a week. It’s a lifelong commitment to learning, even for the most successful traders. Marty Schwartz, a trader interviewed by Jack Schwager for his first Market Wizards title, was a losing trader for several years until finally finding his stride.
Fortunately for you, there’s so many resources easily available to learn about trading the markets. Over time, several strategies have been developed and shared through books and courses, giving you the chance to expose yourself to many styles before picking one to stick with.
So what’s next??
If you’re ready to get serious about day trading then make sure to join our next webinar for an in depth look at some of our most profitable strategies!