Conservative investors typically buy stocks and hold onto them for a few years or longer, to take advantage of the general upward trend that the stock market tends to follow over long periods of time. However, the stock market is fluid, allowing investors to buy and sell a stock on the same day or even within the same hour or minute. Buying and selling a stock the same day is called day trading.
Day Trading Basics
Day traders buy and sell stocks on the same day, trying to profit from daily fluctuations of stock prices. For example, a day trader might purchase stock for $35.50 a share and sell it a couple of minutes later for $35.60 a share, at a profit of 10 cents per share. If the stock's price fell back to $35.50 later in the day, the trader might buy more shares in hope of another price increase. Day traders can buy and sell the same stock several times in the say day.
Day Trading Risks
Day trading is extremely risky because the daily price fluctuations of stocks are impossible to predict. Day traders essentially bet on short-term stock prices. Sometime their gambles pay off, but they can lose money very quickly. According to the U.S. Securities and Exchange Commission, most new day traders suffer severe financial losses, and many day traders never manage to make money.
Even if day traders manage to make money, they typically face higher tax rates than do long-term investors. Gains realized from the sale of stock are subject to capital gains tax. If an investor holds a stock longer than a year, the maximum capital gains tax rate is 15 percent. If an investor holds stock a year or less, the capital gains tax rate is equal to the taxpayer's normal income tax rate. This means day trading gains can be subject to tax rates as high as 35 percent.
Pattern Day Traders
Investors who regularly engage in day trading may be considered "pattern day traders." According to the SEC, a pattern day trader executes four or more day trades within five business days, with day trades accounting for more than 6 percent of the customer’s total trades for that period. Pattern day traders must maintain a minimum account balance of $25,000 and can trade only in margin accounts. Margin accounts let traders borrow money to invest, which increases risk and potential losses.
- U.S. Securities and Exchange Commission: Day Trading: Your Dollars at Risk
- U.S. Securities and Exchange Commission: Pattern Day Trader
- U.S. Securities and Exchange Commission: Margin Rules for Day Trading
- Internal Revenue Service: Ten Important Facts About Capital Gains and Losses
- U.S. Securities and Exchange Commission: Day Trading
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.