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Risk Disclosure: Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.
Performance disclosure. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.
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10 Steps to Becoming a Day Trader
In a world where everyone has easy access to online trading, why are there only a few succeeding as day traders? After all, what investor has not dreamed of becoming a day trader – working comfortably at a home computer, being your own boss, watching profits roll in? While many aspire, few actually succeed.
- Day traders actively engage with the market, employing intra-day strategies to profit off quick price changes in a given security.
- To become a day trader, you must be sure to be well-enough capitalized and have access to an affordable and functional trading platform.
- Day trading can be a lucrative undertaking, but it also comes with a high degree of risk and uncertainty.
- A thorough understanding of markets, financial securities, and behavioral finance – along with personal discipline and focus – are necessary for success.
What Does a Day Trader Do?
A day trader actively buys and sells securities, often multiple times during the day, but without carrying any open positions to the next day. All buy/sell positions taken during a trading day are squared-off on the same day before the market closes. Day traders are different from active traders who may hold a position for multiple days, or from investors who invest for longer periods. Day traders also use leverage to increase their intraday trade exposure.
How To Become A Day Trader
1. Conduct a Self-Assessment
Successful day trading requires a combination of knowledge, skills, and traits as well as a commitment to a lifestyle. Are you adept with mathematical analysis, full of financial knowledge, aware of behavioral psychology (in yourself as well as others), and do you have the stomach for entrepreneurship? Contrary to the perceived notion of an easy life or easy money, day trading actually requires:
- Long working hours
- Very little leave from work
- Continuous self-learning with no guidance
- Risk-taking abilities
- Never-ending commitment to daily activities of the job
The right mindset is the most important (and the very first) requirement in becoming a day trader. Unless one is prepared to devote time, self-learn and be mentally prepared to take risks and suffer losses, do not try day trading. Books like “Trade Your Way to Financial Freedom” by Van Tharp and “The Psychology of Trading” by Brett N. Steenbarger are good resources for learning more about day trading and performing a self-assessment.
2. Arrange Sufficient Capital
No one can generate profits consistently. Intermittent and extended losses are part of the day trading game. (For example, a day trader may suffer eight loss-making trades in a row and only recover with profit on the ninth trade.)
To handle these risks, a day trader must have a sufficient cushion of capital. As Van Tharp explained in “Trade Your Way to Financial Freedom,” entering the trading world with only a small amount of money is a sure path to failure. Before quitting your job to trade full time, Tharp recommends having at least $100,000 for trading. Novices can start with smaller amounts, depending upon their selected trading plan, the frequency of trading, and other costs they bear. To actively day trade it is required that you maintain a balance of $10,000 in your trading account.
3. Understand the Markets
Day traders need a solid foundation of knowledge about how the markets function. From simple details (like exchange trading hours and holidays) to complex details (like the impact of news events, margin requirements, and allowed tradable instruments), a trader needs to have a broad knowledge base.
4. Understand Securities
Stocks, futures, options, ETFs, and mutual funds all trade differently. Without a clear understanding of a security’s characteristics and trading requirements, initiating a trading strategy can lead to failure. For example, traders should know how margin requirements for futures, options, and commodities significantly impact trading capital or how an interim assignment or exercise of an option position can shatter the trading plan completely.
Lack of knowledge about these necessities specific to securities can lead to losses. Aspiring traders should ensure full familiarity with the trading of selected securities.
5. Setup a Trading Strategy
Novice traders entering the world of trading can begin by selecting at least two established trade strategies. Both would act as a backup of each other in case of failure or lack of trading opportunities. One can move on to more number of strategies (with more complexities) later, as the experience builds up.
The trading world is highly dynamic. Trading strategies can consistently make money for long periods but then fail at any time. One needs to keep a close eye on the effectiveness of the selected trading strategy and adapt, customize, dump or substitute it depending upon the developments.
6. Integrate Strategy and Plan
Selecting the right trading strategies alone is not sufficient to succeed in the market. The following considerations need to complement the strategy, to come up with the trading plan:
- How the strategy will be used (entry/exit strategy)
- How much capital will be used
- How much money per trade will be used
- Which assets will be traded
- How frequency to place trades
7. Practice Money Management
Let’s say you have $100,000 as trading capital and an excellent trading strategy that offers a 70 percent success rate (7 trades out of 10 are profitable). How much should you spend on your first trade? What if the first three trades are a failure? What if the average record (7 profitable trades out of 10) no longer holds? Or, while trading futures (or options), how should you allocate your capital to margin money requirements?
Money management helps you address these challenges. Effective money management can help you win even if there are only 4 profitable trades out of 10. Practice, plan and structure the trades according to money management and capital allocation plan.
8. Research Brokerage Charges
Day trading usually involves frequent transactions, which result in high brokerage costs. After thorough research, select the brokerage plan wisely. If one intends to play with one-two trades per day, then a per trade basis brokerage plan would be appropriate. If the daily trading volume is high, go for staggered plans (the higher the volume, the lower the effective cost) or fixed plans (unlimited trades for a fixed high charge)
Apart from trade execution, a broker also offers other trading utilities, which includes trading platforms, integrated trading solutions like option combinations, trading software, historical data, research tools, trading alerts, charting application with technical indicators and several other features. Some features may be free while some may come at a cost which can eat into your profits.
It is advisable to select the features depending upon your trading needs and avoid subscribing to ones which are not needed. Novices should start with the low-cost basic brokerage package matching their initial trading needs and later opt for upgrades to other modules when needed.
9. Simulate and Back Test
Once the plan is ready, simulate it on a test account with virtual money (most brokers offer such test accounts). Alternatively, one can backtest the strategy on historical data. For a realistic assessment, keep consideration for brokerage costs and the subscription fee for various utilities.
10. Start Small and Then Expand
Even if you have sufficient money and sufficient experience, don’t play big on the first trades of a new strategy. Try out a new strategy with a smaller amount and increase the stakes after tasting success. Remember, markets and trading opportunities will remain forever, but money, once lost, may be difficult to re-accumulate. Start small, test to establish, and then go for the big ones.
The Bottom Line
Aspiring traders should beware of websites and courses that promise foolproof day trading success or endless profits. The limited percentage of day traders who have managed to be successful do so by investing their time and efforts into building trading strategies and following them religiously.
A day trader is on his own in this big trading world. Before giving up your job to become a day trader, be sure that you have the motivation to continuously learn, design your trading strategies, and take accountability for your decisions and actions. If you’re looking to jump into the world of day trading, you can use one of the best stock brokers for day trading.
How to Day Trade With Less Than $25,000
When you set up a brokerage account to trade stocks, you might wonder how anyone is going to know whether you’re a bona fide “day trader.” Your broker will know, based on your trading activity.
The Financial Industry Regulatory Authority (FINRA) in the U.S. established the “pattern day trader” rule, which states that if you make four or more day trades (opening and closing a stock position within the same day) in a five-day period and those day-trading activities are more than 6% of your total trading activity in that five-day period, you’re considered a day trader and must maintain a minimum account balance of $25,000.
Background on Day Trading Equity Requirement
Back in 1974, before electronic trading, the minimum equity requirement was only $2,000. New technology changed the trading environment, and the speed of electronic trading allowed traders to get in and out of trades within the same day.
Since day traders hold no positions at the end of each day, they have no collateral in their margin account to cover risk and satisfy a margin call—a demand from a broker to increase the amount of equity in their account—during a given trading day. Brokerage firms wanted an effective cushion against margin calls, which led to the increased equity requirement.
Perhaps you don’t usually day trade but happened to do four or more such trades in one week, with no day trades the next or the following week. In this scenario, your brokerage firm would still likely classify you as a day trader and hold you to the $25,000 equity requirement going forward.
You can meet the equity requirement with a combination of cash and eligible securities, but they must reside in your day trading account at your brokerage firm rather than in an outside bank or at another firm.
If you do not have $25,000 in your brokerage account prior to any day-trading activities, you will not be permitted to day trade. The money must be in your account before you do any day trades and you must maintain a minimum balance of $25,000 in your brokerage account at all times while day trading.
On the plus side, pattern day traders that meet the equity requirement receive some benefits, such as the ability to trade with additional leverage—using borrowed money to make larger bets. A stock day trader can trade with 4:1 leverage, while typical stock investors (including swing traders and those who tend to buy and hold) can trade with a maximum of 2:1 leverage.
Day Trading Loopholes
If you don’t happen to have $25,000 to day trade, there are ways of getting around that requirement. They consist of loopholes and alternative trading strategies, most of which are admittedly less than ideal.
- Make only three day trades in a five-day period. That’s less than one day trade per day, which is less than the pattern day trader rule set by FINRA. However, this means you’ll need to pick and choose among valid trade signals, so you won’t receive the full benefit of a proven strategy.
- Day trade a stock market outside the U.S. You’ll have to do this with a broker that’s also outside the U.S. Not all foreign stock markets have the same account minimums or day trading rules as the U.S. Research other markets and see if they offer the opportunities for day trading that fit your needs. Consult both tax and legal professionals to understand the ramifications before considering this approach.
- Join up with a day trader firm. The structure of each firm varies, but typically you deposit an amount of capital (much less than $25,000) and they provide you with additional capital to trade, with your deposit safeguarding them from losses you may take. Otherwise, the firm simply leverages your capital.
- Do swing trading and enter trades that you hold for longer than one day. Swing traders capture trends that play out over days or weeks rather than attempt to time a one-day trend that might last for 20 minutes. While this is less a loophole and more of a change in strategy, it works for traders who want to stay actively involved but don’t yet have enough equity to meet the $25,000 requirement for day trading.
- Open multiple day trading accounts with different brokers. This is a less-attractive choice, but, for example, if you open two accounts, you can make six day trades in a five-day period—three trades for each broker. This isn’t an optimal solution because, if you already have limited capital, each account is likely to be quite small, and day trading with such small accounts isn’t likely to produce much income. With small amounts of capital in each account, you are severely limited in the stocks you can trade, and some brokers may not even accept the small deposit.
Brokers are out to protect themselves and can impose minimum capital restrictions at their discretion if they believe someone is day trading regularly (even if below the four-trade/five-day threshold) or trading in a risky manner.
Day Trading on Different Markets
A better alternative to taking advantage of a loophole or adopting a different trading strategy is to change markets.
The forex or currencies market trades 24 hours a day during the week. Currencies trade as pairs, such as the U.S. dollar/Japanese yen (USD/JPY). With forex trading, consider starting with at least $500, but preferably more. The forex market offers leverage of perhaps 50:1 (though this varies by broker), so a $500 deposit means you can trade and earn—or lose—off of $25,000 of capital. Profits and losses can mount quickly.
The futures market is where you can trade stock index futures (the E-mini S&P 500, for example) and commodities (such as gold, oil, and copper). Futures are an inherently leveraged product, in that a small amount of capital, such as $400 or $500 in the case of the E-mini contract, gives you a position in a product that typically moves 10 or more points a day, where each point is worth $50. Profits and losses can pile up fast. It’s recommended futures traders start with at least $2,500 (if trading a contract like the E-mini), but that will vary based on risk tolerance and the contract(s) traded.
Almost all day traders are better off using their capital more efficiently in the forex or futures market. These markets require far less capital to get started, and even a few thousand dollars can start producing a decent income.
Day trading the options market is another alternative. Options are a derivative of an underlying asset, such as a stock, so you don’t need to pay the upfront cost of the asset. Instead, you pay (or receive) a premium for participating in the price movements of the underlying. The value of the option contract you hold changes over time as the price of the underlying fluctuates. What type of options you trade will determine the capital you need, but several thousand dollars can get you started.
The Bottom Line
While day trading requires a large amount of equity, there are loopholes and other investment options to consider that may require you to put less of your money on the line. Before investing any money, always consider your risk tolerance and research all of your options.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
How to Become a Trader
Updated: March 28, 2020 | References
This article was co-authored by our trained team of editors and researchers who validated it for accuracy and comprehensiveness. Together, they cited information from 19 references.
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Traders have to be able to quickly analyse lots of information and make well-informed decisions under high levels of pressure. Trading can be very profitable, but is also high risk. You can work for a financial institution, trading with the bank’s money, or money from the bank’s clients. You can also work with your own clients, advising them on good investment opportunities.
How to Become a Full-Time Trader
By Dale Gillham | Last Updated 30 October 2020
Some time ago, I received an all too familiar phone call. It was a gentleman who had been trading the stock market. Having made some money, he told me he was going to take six months’ long service leave and trade options in an effort to become a full-time trader so he would not have to go back to work.
Other than reading a couple of books, he had no education in the stock market and had simply made money in a very bullish market. This is a common theme among traders who believe they are invincible after taking profits from the stock market over a short period of time, particularly when the market is bullish. So what do you think his chances were of becoming a successful trader if he took his long service leave and did nothing more to educate himself?
Statistically, anyone trading options has less than a 5 percent chance of being successful in the long term, but that aside, even if he were to trade stocks, what do you think his chances would have been? At best guess, I would have said less than 50 percent, although, if I am to be truly honest, I believe it would have been less than 30 percent.
If it is your intention to create a lifestyle from trading, you need to follow the “Be, Do, Have” principle. You need to BE a full-time trader, DO what a full-time trader does, and then you will HAVE what a full-time trader has.
Becoming a full-time trader
It can take up to two years for anyone to become a full-time trader, if not longer. Knowledge is everything in the context of trading. The streets are littered with wanna-be traders and, in a bull-market, many are profitable through sheer luck rather than sound knowledge.
To be a full-time trader, you need to combine a high level of knowledge with experience; without this, your probability of success over the long term is very low. When you leave work to trade full time, you no longer have the security of a regular income. This means your attention is often focused on making profits from every trade to pay the bills.
This need for survival often results in the trader trying to trade more to make up for any trading losses or because they are unable to meet their day to day financial needs. Consequently, a spiral of increased pressure begins, resulting in the trader taking higher risks to get back on top. Unfortunately, because of their lack of knowledge and experience, many end up back at work.
Being a full-time trader does not mean you work every day. It simply means that your trading is paying for your lifestyle. This is a very important distinction and one I recommend you ponder if your goal is to trade full time. Trading is about creating a lifestyle, not making it your lifestyle.
Hence, if your goal is to replace your income of $100,000 a year, it does not mean you have to make around $2,000 a week from trading. It just means your total trading profits over one year need to equate to $100,000. Looking at it like that, rather than the micro-view of generating $2,000 a week, will make a dramatic difference to your psychology and how you trade the market.
Capital and percentage return
Another very important point is that you should only subject yourself to the amount of risk you need to achieve your goal(s). For example, if you have $500,000 to invest and you need an income of $50,000 a year, you only need a return of 10 percent. Just buying the top blue chip shares over the medium to longer term should deliver this income in a reasonable market.
If you only have $100,000 to invest and you still require $50,000 in income a year, you will need to generate a 50 percent return on your capital. Therefore, you will need to trade shares that assist you in producing this return or use leveraging in your trading plan.
If your goal is to trade full time, I highly recommend you prove to yourself that you can not only trade but also make the sort of income you want from trading while still working. And you should do this for an absolute minimum of six months although, 12 months is preferable. Now, I can hear some of you saying, “But if I give up work, I will have more time to trade and, therefore, I will naturally get better returns.” My response to this is: prove it. It simply does not work that way.
If you can replace your income by trading while still in a full-time job, not only will your confidence increase but you will also have built up a sum of money to draw upon when you do finally go on to be a full-time trader. Having this “safety’ margin” is one of the smartest plans you can have as well, and it is one of the main strategies for building wealth.
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What exactly is a “safety” margin? It is simply a fail-safe plan in case things go wrong. For example, if you use leveraging to invest, you could avoid using all of the available funds that the lender provides. If you want to be a full-time trader and trade for a lifestyle, the having a safety margin means having enough cash in the bank to sustain your lifestyle for at least 6 to 12 months. This will give you more options when something does go wrong.
All too often I see traders attempting to trade full time without enough cash to support themselves end up trading short term and taking higher risks. This only results in making trading decisions based on the need to derive an income rather than on good trading techniques. Consequently, they end up exiting trades when they should hold or entering trades in the hope of a quick profit. However, you should never place yourself in the position of relying on emotional decisions as this is a trader’s greatest downfall.
One of the biggest misconceptions about becoming a full-time trader is that you need to trade short term. If your capital limits you to trading this time frame, I recommend you revert to my original proposed strategy of trading while working full time. Failure to do so will place you at high risk of losing your capital and ending up back at work regardless.
Portfolio set up
The best way to set yourself up if you want to trade full time is to follow my four golden rules to investing. This involves allocating 90 percent of your capital to a medium to long-term portfolio that will perform year in year out, and allocating the remaining 10 percent to short-term trading to generate cash flow. This ensures you are protecting your capital by not subjecting the majority of it to high-risk trades.
For example, if you have $200,000 in capital and you need to make $50,000 in income, your asset allocation would be $180,000 in a safe, medium-term portfolio, with the average trade length between seven and eighteen months. If you averaged a 12 percent return on this portfolio each year including dividends, you would receive $21,600, which means you only need to make $28,400 from your short-term trading account. Therefore, the $20,000 in capital allocated to your short-term trading needs to generate, on average, just over $2,366 per month.
Now let’s assume you decide to use leveraging to trade short term, which in some markets allows you to leverage ten times your capital. This means you would have $200,000 to invest. Therefore, if you trade a stock using leverage, it only has to rise around 1.5 percent in a month for you to make around $2,366 per month, assuming you only invest 80 percent of your available capital ($160,000) for short-term trading in four leveraged positions so as to minimize your risk. This is very achievable and, more importantly, very repeatable for someone who has acquired the knowledge and skill and has the experience.
Some instruments, such as Forex, allow you to trade on a margin of 1 or 2 percent, although this is not recommended unless you are extremely proficient as a trader and have the time and knowledge to manage this risk. That said, if you allocated $20,000 to trade on a margin of 1 percent, you would have $2 million in your short-term trading account. To achieve the same return trading on a margin of 10:1, all you would need to do is move the decimal point by one place, which means the trade only needs to rise around 0.15 percent in a month for you to make around $2,366 per month. This assumes you have only invested 80 percent of your available capital for short-term trading in four leveraged positions.
Consider going part time
People often want to start trading the stock market because they are sick of working full time and desire a change in their lifestyle. Getting up at six a.m. is not exactly exciting, especially when working for a company that does not pay well or appreciate your efforts. If it is your desire to have the profits from your trading pay for your lifestyle, I recommend you transition to trading full time by working part time rather than giving up work entirely. This has huge benefits, as your psychology will slowly adjust to being less dependent on a steady income stream.
Working part time will also allow you to transition to a life of deriving your income from trading. Funnily enough, people find they actually crave work again after they leave.
At my recent Art of Trading workshop, a client shared how he was in the process of decluttering his life while transitioning to trading for a lifestyle. He had reduced his hours at work, and on his days off he was honing his trading skills to enable him to replace his income in its entirety. He also shared that in the process he was selling things he did not need and downsizing his living arrangements so he could travel and enjoy the benefits of his new lifestyle.
It’s worth mentioning, however, that trading for a lifestyle is not for everyone; it can be lonely—you are home alone while your friends are at work, and this can lead to boredom. Some people I know have taken up hobbies or charity work to keep themselves occupied, while others have gone back to work even though they were successful in generating sufficient income from their trading to maintain their lifestyle. Before you leap, it is important to consider the changes that will occur to your lifestyle.
The transition to trading for a lifestyle is a journey; it is not something that happens overnight. Some people find when they get there that it is the best thing they have ever done, but others find it is not for them. Whether you ultimately decide to trade for a lifestyle or not, the most important point is that you enjoy and profit from the journey.
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