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Day Trading For Dummies, 3rd Edition

Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com

Copyright 2014 by John Wiley & Sons, Inc., Hoboken, New Jersey

Published simultaneously in Canada

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Library of Congress Control Number: 2013954192

ISBN 978-1-118-77960-6 (pbk); ISBN 978-1-118-80813-9 (ebk); ISBN 978-1-118-80808-5 (ebk)

Manufactured in the United States of America

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Chapter 1

In This Chapter

Figuring out just what day traders do

Setting up a trading business

Concentrating on a few assets, a few dollars at a time

Knowing what being a successful trader takes

Dispelling a few day-trading myths

Make money from the comfort of your home! Be your own boss! Beat the market with your own smarts! Build real wealth! Tempting, isn't it? Day trading can be a great way to make money all on your own. It's also a great way to lose a ton of money all on your own. Do you have the fortitude to face the market every morning?

Day trading is a crazy business. Traders work in front of their computer screens, reacting to blips, each of which represents real dollars. They make quick decisions because their ability to make money depends on successfully executing a large number of trades that generate small profits. They close out their positions in the stocks, options, and futures contracts they own at the end of the day, which limits some of the risks nothing can happen overnight to disturb an existing profit position but those limits on risk can limit profits. After all, a lot can happen in a year, increasing the likelihood that your trade idea will work out, but in a day? You have to be patient and work fast. Some days offer nothing good to buy. Other days, every trade seems to lose money.

The individual human-being day trader is up against a tough opponent: high-frequency algorithms programmed and operated by brokerage firms and hedge funds that have no emotion and can make trades in less time than it takes to blink your eye. If you're not prepared for that competition, you will be crushed.

In this chapter, I cover what day traders do, share the advantages and disadvantages of day trading, list the personality traits of successful day traders, and give you information on your likelihood of success. You may find that day trading is a great career option that takes advantage of your street smarts and clear thinking or that the risk outweighs the potential benefits. Either is okay: The more you know before you make the decision to trade, the greater your chance of being successful. If you decide that day trading isn't right for you, you can apply strategies and techniques that day traders use to improve the performance of your investment portfolio.

The definition of day trading is that day traders hold their securities for only one day. They close out their positions at the end of every day and then start all over again the next day. By contrast, swing traders hold securities for days and sometimes even months; investors sometimes hold for years. The short-term nature of day trading reduces some risks, because nothing can happen overnight to cause big losses. Meanwhile, many other types of investors go to bed thinking their position is in great shape only to wake up the next morning to find that the company has announced terrible earnings or that its CEO is being indicted on fraud charges.

But there's a flip side (there's always a flip side, isn't there?): The day trader's choice of securities and positions has to work out in a day, or it's gone. Tomorrow doesn't exist for any specific position. Meanwhile, the swing trader or the investor has the luxury of time, because it sometimes takes a while for a position to work out the way your research shows it should. In the long run, markets are efficient, and prices reflect all information about a security. Unfortunately, a few days of short runs may need to occur for this efficiency to kick in.

Day traders are speculators working in zero-sum markets one day at a time. That makes the dynamics different from other types of financial activities you may have been involved in. When you take up day trading, the rules that may have helped you pick good stocks or find great mutual funds over the years no longer apply. Day trading is a different game with different rules.

Professional traders fall into two categories: speculators and hedgers. Speculators look to make a profit from price changes. Hedgers look to protect against a price change. They make their buy and sell choices as insurance, not as a way to make a profit, so they choose positions that offset their exposure in another market.