Wikipedia defines Day trader as "A day trader is a trader who buys and sells financial instruments (eg stocks, options, futures, derivatives, currencies) within the same trading day such that all positions will usually be closed before the market close of the trading day. This trading style is called day trading. Depending on one's trading strategy, it may range from several to even a hundred orders a day.". And the process of trading is called Day Trading.
Types of Day Traders:
Institutional Day Traders:
This type of investor performs trading on behalf of a large financial institution. He has an edge over individual investors as he has access to huge financial resources,high-end analytical softwares that keep him informed and in several cases, a team that aids him in the process.
Individual Investors:
An individual investor is the one who invests his/her own funds or funds borrowed personally. Historically, these investors have been trading through middlemen. However, with the boom in internet and also cheaper loans, trading has become more convinient for individual traders too. Nowadays, Direct Access is available to the individual traders, wherein, the transaction is made and confirmed in a split second, which is faster than the conventional method.
Day Trading
Day traders generally borrow the money they invest. This money is termed as "Call Money".They bet their profits on the difference between the return on investment and the rate at which they borrowed. The rate at which they borrow the Call Money is the "Call Money Rate".
Margin:
It is the collateral that the trader has to pay to cover for the credit risk to hold positions.
An example would better explain what margin actually is.
If the margin is put at 25%, it means that the trader can buy and trade stocks worth $100 by paying a collateral of just $25, as long as half the stock options are sold by the end of the trading day.
Techniques used by Day Traders:
Before we proceed to know about the techniques used by Day traders, you will be introduced to a few terms which form the basis for further understanding.
Short Selling or Shorting:
Shorting is the process of buying stocks at a price and immediately buying them back.
Example:
Suppose that the stocks of a company XYZ are trading at $10 at present. The trader buys 100 stocks at $10 and sells them immediately. After a while, when the stock is trading at $8, he buys back the 100 stocks for $8 each. Eventually, he has the same number of shares and also the $200 that he saved. Short selling could lead to losses too. Supposing thjat the stock raises to $15, he has to buy back the shares for $1500, thereby paying an additional $500.
Having known this, you are ready to know the various techniques used by day traders.
Trend follower approach:
The trader observes the trend of the stock over a period of time. He expects the same trend to continue and bases his trade on this same trend. If there is an uptrend, he buys the stock and waits for the stocks to increase in value to sell and make a gain. If a downtrend is observed, he "Short sells" the stock with an exception of further downtrend to buy them back and make a gain.
Contrarian:
In this approach, the trader expects a reversal of the observed trend. That is, if there is an uptrend, he expects a reversal to a downtrend and viceversa if there is a downtrend. If there is an uptrend at present, he expects a fall in the stock value and Short Sells; if there is a downtrend, he expects a raise in the value and buys them and waits for the value to raise to sell and make profit.
Scalping:
Scalping is the practice of buying a security for one's own account before recommending it to another as a long term investment. In the process, he sells the security for a higher price, making a profit. This is generally done in huge volumes to maximise gains even if the margin is low for the short period of holding.
This practice has been prohibited for traders who are not Investment Advisors. However, several day traders violate this prohibition and still make gains!
Rebate Trading:
This method of trading is suited to high volume trading. When a trade is performed over Electronic Communication Network(ECN). Traders place bids and offers on the ECN. The ECN charges a fee for those who hit the bid and take the offers. Part of this fee is passed on those who posted the bids as a rebate. When trading in high volumes(generally in the scale of millions), the rebates workout to be a huge profit. A day trader minimises his loss or extends his profit by doing this.
Yet another method of trading used by day traders is to base thier decisions on the news. Depending on the news pertaining to a specific company, he makes a decision. That is, if there is a bad news, he short sells the stock and, if there is good news, he buys stock in anticipation of an increase.
Thursday, February 7, 2008
Day Trading
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