Like HowStuffWorks on Facebook!

How Day Trading Works


Characteristics of a Day Trader
Got a business plan and experience? If not, you could get lost in the vast realm of day trading, like many traders before you.
Got a business plan and experience? If not, you could get lost in the vast realm of day trading, like many traders before you.
©iStockphoto/hjalmeida

In theory, anyone could become a Formula One racecar driver, but in reality, very few people possess the right skills or temperament for such a demanding sport. The same is true for day trading. Day traders must possess certain personality traits and have access to certain resources if they're to be successful.

These are the essentials.

  • Knowledge and experience in the markets- Day traders must have an understanding of market fundamentals if they're going to succeed. Most have many years of experience investing and trading in the various markets. They also research constantly, using services provided through a full-service online brokerage account or information from publications like the Wall Street Journal, to gauge market sentiment.
  • Capital- "It takes money to make money" is a cliché that resonates with day traders. That's because they often borrow money -- called leverage -- to use in the market. While this is risky, it's absolutely necessary. Using a large amount of capital to make many smaller trades increases potential returns.
  • A business plan- Day trading is a business and, as such, requires a business plan. Most plans address short- and long-term goals, target markets, trading hours and days, business setup needs, capital reinvestment, tax considerations, reporting and metrics.
  • Discipline- Day traders separate themselves from their emotions and never act impulsively. They always work with risk capital (which is money they can afford to lose), they use stop and limit orders to reduce losses, and they always close out at the end of the day.
  • Technology- Day trading functions through electronic communication networks. A trader accesses these networks using a computer and a high-speed connection. A typical setup might include two monitors working off one PC, a second clone computer to serve as a backup, cable broadband with a DSL backup, and a wireless router for a laptop. Many day traders use analytical software to search for trades, receive information, execute trades and manage accounts.

People who attempt to trade without these attributes or resources are very likely to fail, and many do. Those that succeed encounter a severe learning curve. Once they gain experience, traders often take up day trading professionally, either as part of a larger institution or as lone rangers. Institutional day traders work shoulder-to-shoulder with other traders in large, computer-laden trading rooms. Individual day traders work from their homes or offices.

Either way, it's a full-time occupation. Part-time day trading is possible, but difficult. Those who adopt a part-time approach still treat their trading as a business. They set a schedule -- and follow it religiously. This discipline distinguishes them from hobbyists or those who experiment with day trading as a form of gambling. In fact, many compulsive gamblers have lost significant sums of money attempting to day trade, compelling Gamblers Anonymous to open a day trading division.