You probably have heard horror stories about day trading being a high stress, risky venture that requires substantial capital. In truth, these stories mostly apply to naive traders who overtrade, are poorly versed in techniques for controlling risk, and consequently have large swings in capital. Such individuals are more like gamblers than speculators or professional traders.
High levels of risk and large equity swings are not intrinsic to day trading . Instead, they are due to trading an excessive number of contracts or shares, and to using inappropriate orders that allow unanticipated price changes to cause catastrophic losses. For a constant number of contracts or shares, shorter trades actually mean reduced exposure and lower risk. Because the risk from a short-term trade on a per-contract basis is less, the money needed for day trading is less than for longer-term, "position," trading. This is reflected in the margin requirements for many futures contracts, where the overnight margin is significantly higher than the within-the-day margin.
There are other reasons that risk is less for the day trader than for the position trader. Day trading permits a fairly quick response to market behavior. Because of the speed with which the trader can act, the continuing loss of capital caused by a market moving in the wrong direction can quickly be curtailed. And, since positions are not held overnight, the risk incurred from overnight gaps is eliminated.
Not only is there the potential for lower risk., but many trades can be taken in a very short period. This means that the trader will experience frequent feedback, or, equivalently, many rewards and punishments. He or she will, therefore, be able to quickly learn the art of profitable trading. In a sense, what might take years of longer-term trading experience can be condensed into a few weeks or months.
There is some danger in day trading for the knowledgeable and disciplined trader, but it is not the one that most people fear or read about. The danger is a possible slow death through attrition. This risk derives from the same features of day trading that provide the benefits. Small moves that occur over short periods of time not only mean lower per-trade risk, but also smaller per-trade profits. With smaller per-trade profits, commissions and slippage can impact trading quite significantly. Consequently, although any one trade may involve little risk of serious loss, large numbers of mildly losing trades can gradually devastate an account.
The constant drain of slippage and commissions can easily lead to a steady stream of small losses if one's trading is close to random. Given the frequency of trading by the day trader, these small losses can add up. This means two things. One, as in any form of trading, the day trader needs a statistical edge, something that provides a better-than-chance batting average that is sufficient to overcome the costs of trading. And, two, it becomes extremely important to minimize, to the greatest extent possible, all transaction costs: Commissions must be cut to the bone, and various techniques must be used to minimize slippage and get good prices. Commissions can be reduced by carefully selecting the brokerage that will route your orders to the markets. Brokerage firms vary widely in their commissions, as well as in the quality of their fills.
