Day trading
Day trading refers to the process of trading stocks through "making the spread"; in essence, becoming a private, freelance market maker, buying at the Bid price and selling at the Ask price. Day trading is not the practice of buying stock and holding it for a short period of time in hopes the price goes up and then selling for a profit. This type of trading is known as swing trading (or position trading) - whether the trader holds the stock for a few months or a few minutes. Day trading is entirely different from swing trading. This common misconception is a significant part of what leads most new day traders into financial ruin.
The Spread
When a securities trader looks at a particular stock quote, he sees a number of informational items. Two of these items are the Bid and Ask price. The numerical difference between these two prices is known as the spread. The bigger the spread, the more inefficient the market for that particular stock, and the more potential for profit. This spread is the mechanism that large Wall Street firms use to make most of their money (as opposed to trade commissions) since the advent of online discount brokerages.
ÃÂÃÂMaking the spread"
To make the spread means to simply buy at the Bid price and sell at the Ask price. This is referred to as momentum trading when done on the NASDAQ; when done on the NYSE, it is referred to as scalp trading, and follows slightly different rules. This procedure allows for profit even when the stock price never moves, and is where the phrase ÃÂÃÂrazor thin profitsÃÂÃÂ come into play.
When the typical online investor places a market order to buy a stock, his broker submits this order to a market maker (MM), who then fulfills the order at the Ask price. In other words, the Ask price is the price the MM is asking for the stock. When the typical online investor places a market order to sell a stock, the broker submits the order to a MM and sells at the Bid price, i.e. what the MM is bidding for the stock.
Due to the liquidity of the modern market, orders are constantly flowing. Many times, a MM will buy a stock just to turn around and sell it to a particular broker. In fact, this is one of the primary purposes of the MM ÃÂÃÂ to maintain liquidity in the market (among other things). Through this transaction, the MM will profit anywhere from a few cents to a whole dollar per share, in average circumstances. Over the course of a single day, a MM may fill orders for hundreds of thousands or millions of shares.
Day traders, through the use of modern technology and recent regulations changes (within the last 15 years), cut in on the MMÃÂÃÂs business action, and take a piece of the pie for themselves. By cutting out many of Wall StreetÃÂÃÂs heavy hitters, day traders have raised the ire of the power elite which, in turn, have created a dim public image of day traders, calling them such things as ÃÂÃÂbanditsÃÂÃÂ in the first few years, and discouraging many potential traders from ever entering the market.
Day traders are able to buy at the Bid price and sell at the Ask price through buying access to Direct-Access Broker systems such as TradeStation, which generally require a $25,000 upfront depost or more, rather than by trading through retail brokers. The average online investor uses a retail broker. (All of the brokerages that advertise $15, $10, or $5 commissions to the general public are retail brokers.) Through direct-access brokerage systems, day traders send their orders directly to the ECNss, instead of indirectly through brokers. ECNs put day traders on the same level as MMs.