Day Trading Articles

Cheat Sheet / Updated 08-30-2021

Unlike other types of stock trading and investing, day trading involves holding securities for only one day. Day trading is risky and it can be stressful, especially if you’re not prepared. Find out what personality traits you should have if you’re considering a career in day trading, useful websites for Canadian day traders, and a list of the most common mistakes day traders tend to make.

Article / Updated 07-06-2021

Day traders have expenses. They buy computer equipment, subscribe to research services, pay trading commissions, and hire accountants to prepare their taxes. It adds up, and the tax code recognizes that. That’s why day traders can deduct many of their costs from their income taxes. You’ll make your life as a day trader much easier if you keep track of your expenses as you incur them. You can do this in a notebook, in a spreadsheet, or through personal finance software such as Quicken. You can deduct investment expenses as miscellaneous itemized deductions on Schedule A of Form 1040 as long as they're considered to be ordinary, necessary, and used to produce or collect income, manage property held for producing income, and directly related to the taxable income produced. Day trading expenses you can deduct: Clerical, legal, and accounting fees: You might use the services of a lawyer to help you get set up, and you'll definitely want to use an accountant who understands investment expenses to help you evaluate your trading strategy and prepare your income tax returns. You can deduct attorney and accounting fees related to your investment income. Office expenses: If you do your day trading from an outside office, you can deduct the rent and related expenses. You can deduct the expenses of a home office, too, as long as you use it regularly and exclusively for business. Whether or not you deduct your office, you can deduct certain office expenses for equipment and supplies used in your business. You can usually write off roughly $100,000 in computers, desks, chairs, and the like if you use them for trading more than half the time. (The limits change every year.) Investment counsel and advice: The IRS lets you deduct fees paid for counsel and advice about investments that produce taxable income. This includes books, magazines, newspapers, and research services that help you refine your trading strategy. It also includes anything you might pay for investment advisory services. Safe deposit box rent: Have a safe deposit box down at the bank? You can deduct the rent on it if you store any investment-related documents. If you also keep other personal items in the same box, you can only deduct part of the rent. Investment interest: If you borrow money as part of your strategy, and most day traders do, you can deduct the interest paid on those loans as long as it isn't from a home mortgage (that interest is already deductible) and as long as you're not subject to other limitations. In most cases, this is margin interest, and for most day traders, it's relatively small because few day traders borrow money for more than a few hours at a time. State income taxes: If you itemize your deductions, you can deduct state income taxes on interest income that is exempt from federal income tax. But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. In most cases, exempt income is related to government bond transactions, and few day traders will work in those markets. The 50 states all have different rules about taxation of investment income. Some states with little or no income tax handle investments differently. Because there are so many different issues, state taxation is beyond the scope of this article. Check with your state revenue department and a state-savvy tax expert to see what you need to know where you live. What You Cannot Deduct Day traders incur some expenses that can’t be deducted from income taxes. It’s disappointing, but at least if you know what day trading expenses they are upfront, you can plan accordingly. Commissions: Every time you make a trade, you have to pay a commission to your broker. It may be small, but you have to pay it. And you can’t deduct that cost. Before you splutter in outrage, read this: You can’t deduct it, but you can add it to cost and subtract it from the proceeds of your trade. Including the commission in the basis of your trade works like a deduction in terms of the amount of tax you pay, but it’s better for you that it’s not a deduction because it’s not subject to the limitations that affect the deductibility of other expenses. If your state charges transfer taxes on securities, they are handled the same way as commissions. Stockholder's meetings: Companies hold annual meetings for their shareholders each year, usually at or near the company headquarters. Sometimes they are deathly dull, but others are extravaganzas where the company shows off new products, showcases major accomplishments, and takes questions from anyone in attendance. And a few involve contentious issues that can lead to protests and fighting, which is entertaining to watch if you aren’t directly affected. For long-term investors, these meetings can offer valuable insights on a company’s prospects. Day traders probably wouldn’t find them very useful. Either way, the IRS won’t let anyone deduct the costs of transportation, hotel stays, meals, and other expenses involved in attending a stockholders’ meeting. Investment seminars: The financial services industry offers all kinds of conventions, cruises, and seminars for day traders. You could spend your days attending training seminars instead of actually trading, if you were so inclined. You’re welcome to go to these, and in many cases, you should. You might learn things that would help you trade more effectively. However, you can’t deduct the costs. There’s some gray area here. You can’t deduct the costs of attending seminars, but you can deduct the costs of investment counsel and advisory services. Some seminars might qualify as investment advice. This is why you need an experienced tax adviser to help you out. Did you notice that two of the nondeductible expense categories have the potential to involve travel? The IRS does not want people buying ten shares of Hawaiian Electric Industries stock and then trying to write off a trip to the company’s annual meeting in Honolulu, nor do they consider cruises that happen to include a talk by the author of a book on investing to be bona fide investment counsel. They see these activities as vacations, and vacations are not tax deductible.

Article / Updated 07-06-2021

Day trading is a cousin to both investing and gambling, but it is not the same as either. Day trading involves quick reactions to the markets, not a long-term consideration of all the factors that can drive an investment. It works with odds in your favor, or at least that are even, rather than with odds that are against you. Investing is slow and steady Investing is the process of putting money at risk in order to get a return. It’s the way that businesses get started, roads get built, and explorations get financed. Investing is very much focused on the long term. Good investors do a lot of research before committing their money because they know that it will take a long time to see a payoff. Investors often invest in things that are out of favor, because they know that, with time, others will recognize the value and respond in kind. In contrast to investing, day trading moves fast. Day traders react only to what’s on the screen. There’s no time to do research, and the market is always right when you’re day trading. You don’t have two months or two years to wait for the fundamentals to work out and the rest of Wall Street to see how smart you were. And if you can’t live with that, you shouldn’t be day trading. Day trading works fast Trading is the act of buying and selling securities. All investors trade, because they need to buy and sell their investments. But to investors, trading is a rare transaction, and they get more value from finding a good opportunity, buying it cheap, and selling it at a much higher price sometime in the future. But traders are not investors. Traders look to take advantage of short-term price discrepancies in the market. In general, they don’t take a lot of risk on each trade, so they don’t get a lot of return on each trade, either. Traders act quickly. They look at what the market is telling them and then respond. They know that many of their trades won’t work out, but as long as more than half work, they’ll be okay. They don’t do a lot of in-depth research on the securities they trade, but they know the normal price and volume patterns well enough that they can recognize potential profit opportunities. Trading keeps markets efficient because it creates the short-term supply and demand that eliminates small price discrepancies. It also creates a lot of stress for traders, who must react in the here and now. Traders give up the luxury of time in exchange for a quick profit. Speculation is related to trading in that it often involves short-term transactions. Speculators take risks, assuming a much greater return than may be expected, and a lot of what-ifs may have to be satisfied for the transaction to pay off. Many speculators hedge their risks with other securities, such as options or futures. Gambling is nothing more than luck A gambler puts up money in the hopes of a payoff if a random event occurs. The odds are always against the gambler and in favor of the house, but people like to gamble because they like to hope that, if they hit it lucky, their return will be as large as their loss is likely. Some gamblers believe that the odds can be beaten, but they are wrong. They get excited about the potential for a big win and get caught up in the glamour of the casino, and soon the odds go to work and drain away their stakes.

Article / Updated 07-06-2021

Several vendors have risen to meet the challenge of backtesting (using historical data to reconstruct trades that would have occurred in the past) and simulation so day traders can try out their strategies before they lay down real money. This list is by no means exhaustive, nor is it an endorsement of their services. It’s just a good place for you to start your research. AmiBroker AmiBroker offers a robust backtesting service at a relatively low price. For that reason, it’s a popular choice with people who are getting started in day trading. It also allows users to make sophisticated technical charts that they can use to monitor the markets. One drawback is that you may have to pay extra for the market price quote data, depending on what securities and time periods you want to test. Strategy Tester Charles Schwab's Strategy Tester lets you test your trading idea. Then you can set it into a Strategy Ticker, which follows your strategy while the market is open, enabling you to see how your strategy performs in real time. This isn’t quite the same as paper trading because it isn’t testing how well you would pull the trigger. Investor/RT Developed by a company called Linn Software, Investor/RT allows you to develop your own tests and create your own programs. It has packages for Macintosh OS X, which makes it popular with traders who prefer Apple computers. Its users tend to be sophisticated about their trading systems and backtesting requirements; this software isn't really for beginners. MetaStock As the name implies, MetaStock is designed for traders who work in stocks, although a MetaStock package is available especially for currency traders, and the regular packages include capabilities for futures and commodities traders. It defines traders as end-of-day (those who make decisions about trading tomorrow based on numbers at the end of today's trading) and as real-time (those who make decisions during the trading day). Most day traders are real-time traders. The company is owned by Thomson Reuters, a major financial information services company. OptionVue If you trade options, you may want to check out OptionVue which offers a range of analytical tools on the options markets. The software's BackTrader module, an add-on feature, helps you learn more about options markets, test new strategies, and examine relationships between options and the underlying stocks — really useful information for people working in equity markets. Trading Blox The Trading Blox software system was developed by professional traders who needed to test their own theories and who didn’t want to do a lot of programming to do it. It comes in three versions (and price levels), ranging from basic to sophisticated, and the company boasts that it works with some commercial trading firms. Of course, some of its capabilities may be more than you need when you’re starting out. TradeStation TradeStation is an online broker that specializes in services for day traders. Its strategy testing service lets you specify different trading parameters, and then it shows you where these trades would have taken place in the past, using price charts. It also generates a report of the strategy, showing dollar, percentage, and win-loss performance over different time periods. It doesn’t have a trade simulation feature.

Article / Updated 07-01-2021

Income seems like a straightforward concept, but little about taxation is straightforward. To the IRS, the money you make as a day trader falls into different categories, with different tax rates, different allowed deductions, and different forms to fill out. Don't worry, we're going to cover those here and make it as straightforward as possible. Earned income Earned income includes wages, salaries, bonuses, and tips. It's money that you make on the job. But even if day trading is your only occupation, your earnings are not considered to be earned income. This means that day traders, whether classified for tax purposes as investors or traders, don't have to pay the self-employment tax on their trading income. Isn't that great? Maybe. Maybe not. The self-employment tax, the bane of many an independent businessperson, is a contribution to the Social Security fund. The problem is that if you don't have earned income, you aren't paying into Social Security, which means that you might not be eligible for retirement benefits. To collect benefits, you have to have paid in 40 credits, and you can earn a maximum of four credits per year. Most employees do this easily, but if you have taken time off work or have a long history of work as an independent investor, you may not have paid enough in. Any benefits you do collect are based on the 35 years of highest earned income over your work history. Your years of independent trading show up as years with zero earned income, and that might hurt your ultimate benefit. Investment income Investment income is your total income from property held for investment before any deductions. This includes interest, dividends, annuities, and royalties. It does not include net capital gains, unless you choose to include them. Do you want to include them? Well, read the next section. Other than net capital gains, which you might or might not decided to include, most day traders have very little investment income for tax purposes. Capital gains and losses A capital gain is the profit you make when you buy low and sell high. The opposite of a capital gain is a capital loss — selling an asset for less than you paid for it. Investors can offset some of their capital gains with some of their capital losses to reduce their tax burden. Those who trade frequently will have many capital gains and losses, though, and they may very well run afoul of complicated IRS rules about capital gains taxation. When designing your trading strategy, think long and hard about how much pain taxes might cause. The financial world is filled with horror stories of people who thought they found a clever angle on making big profits, only to discover that their tax liability was greater than their profit. In the real world, taxes matter. Capital gains come in two flavors: short term and long term. You're charged a low rate on long-term capital gains, which right now is defined as the gain on assets held for more than one year. How low? It's 15 percent right now. Short-term capital gains, which are those made on any asset held for one year or less, are taxed at the ordinary income rate, probably 28 percent or more.

Article / Updated 07-01-2021

After you put your day trading strategy to work during the trading day, it’s easy to let the energy and emotion overtake you. You can get sloppy and stop keeping track of what’s happening. And that’s not good. Day trading is not a video game; it’s a job (to be honest, it would be a pretty terrible video game). Keeping careful records helps you identify not only how well you follow your strategy but also ways to refine it. These records can also show you how successful your trading is, and it makes your life a lot easier when tax time comes around. Set up your spreadsheet The easiest way to get started tracking your trades is with a spreadsheet. Set up columns for the asset being purchased, the time of the trade, the price, the quantity purchased, and the commission. Then set up similar columns to show what happens when the position is closed out. Finally, calculate your performance based on the change in the security’s price and the dollars and percentage return on your trade. You can use this sample to make your own trade-tracking spreadsheet. Some brokerage firms and trading platforms automatically store your trade data for analysis. You can then download the data into your own spreadsheet or work with it in your trading software, making analysis simple. If you make too many trades to keep track of manually, then this feature will be especially important to you. Profit and loss statement If you look at the bottom of the trade tracking spreadsheet, you see some quick summary statistics on how the day’s trading went: trading profits net of commissions, trading profits as a percentage of trading capital, and the ratio of winning to losing transactions. This information should be transferred into another spreadsheet so that you can track your ongoing success. A sample profit and loss spreadsheet At the end of the trading week, calculate your hourly wage. That number, more than any other, can help you see whether it makes sense for you to keep trading or whether you’d be better off pursuing a different line of work. The trading diary A trading diary gives you information to systematically assess your trading. Write down why you are making a particular trade when you make it. (If you wait until later, you’ll forget, and you’ll change your logic to suit your needs.) Was the reason because of a signal from your system? Because of a hunch? Because you saw an opportunity that was too good to pass up? Because your clairvoyant aunt called you with a prediction? Some traders create a form and make copies of it so they can easily fill them out during the day. They even create predetermined indicators that match their strategies and that they can check off or circle. At the end of the day, they collect their diary sheets into a three-ring binder that they can refer back to when the time comes to evaluate their trading strategy and performance. A trading diary should be customized to your own preferences. If your trading style is so fast that you don’t have time to fill it out, come up with some kind of shorthand that lets you keep a running tally of trades made based on a signal from your system, trades based on your own hunches, and trades based on other interpretations of market conditions. Then match your notes against the trader confirmations from your broker to see how you did. Good luck!

Article / Updated 07-01-2021

Day trading income is comprised of capital gains and losses. A capital gain is the profit you make when you buy low and sell high — the aim of day trading. The opposite of a capital gain is a capital loss, which happens when you sell an asset for less than you paid for it. Investors can offset some of their capital gains with some of their capital losses to reduce their tax burden. Suppose you love LMNO Company, but the price of the shares is down from what it was when you purchased them. You’d like to get that loss on your taxes, so you sell the stock, and then you buy it back at the lower price. You get your tax deduction and still keep the stock. How excellent is that? It’s too excellent to be true. This trick is called a wash sale, and the IRS does not count the loss. The wash-sale rule was designed to keep long-term investors from playing cute with their taxes, but it has the effect of creating a ruinous tax situation for naïve day traders. See the rule in action Under the wash-sale rule, you cannot deduct a loss if you have both a gain and a loss in the same security within a 61-day period. (That’s calendar days, not trading days, so weekends and holidays count.) However, you can add the disallowed loss to the basis of your security. Here’s an example to illustrate. On Tuesday, you bought 100 shares of LMNO at $34.60. LMNO announced terrible earnings, and the stock promptly dropped to $29.32, so you sold all 100 shares for a loss of $528. Later in the afternoon, you noticed that the stock had bottomed and looked like it may trend up, so you bought another 100 shares at $28.75 and resold them an hour later at $29.25, closing out your position for the day. The second trade had a profit of $50. You had a net loss of $478 (the $528 loss plus the $50 profit). Here’s how this works out tax-wise: The IRS disallows the $528 loss and lets you show only a profit of $50. But it lets you add the $528 loss to the basis of your replacement shares, so instead of spending $2,875 (100 shares times $28.75), for tax purposes, you spent $3,403 ($2,875 plus $528), which means that the second trade caused you to lose the $478 that you added back. On a net basis, you get to record your loss. The basis addition lets you work off your wash-sale losses eventually, assuming that you keep careful records and have more winning trades than losing ones in any one security. To make the calculations easier, several different tax software packages can download trade data from your brokerage account to keep track of your tax situation. One to check out is TradeLog. Even if you hire someone to do your taxes, tracking your potential liabilities as you trade can help you avoid costly mistakes. The wash-sale rule applies to substantially similar securities. LMNO stock and LMNO options are considered to be substantially similar, so you can’t get around the rule by varying securities on the same underlying asset. LMNO shares and shares of its closest competitor, PQRS, would probably not be considered substantially similar, so you can trade within a given industry to help avoid wash-sale problems.

Article / Updated 03-26-2016

For many people, the attraction of day trading is that traders can very much control their own hours. Many markets, like foreign exchange, trade around the clock. And with easy Internet access, day trading seems like a way to make money while the baby is napping, on your lunch hour, or working just a few mornings a week in between golf games and woodworking. That myth of day trading as an easy activity that can be done on the side makes a lot of traders very rich, because they make money when traders who are not fully committed lose their money. Day trading is a business, and the best traders approach it as such. They have business plans for what they will trade, how they will in invest in their business, and how they will protect their trading profits. If you catch a late-night infomercial about trading, the story will be about the ease and the excitement. But if you want that excitement to last, you have to make the commitment to doing trading as a business to which you dedicate your time and your energy. Can you make money trading part-time? You can, and some people do. To do this, they approach trading as a part-time job, not as a little game to play when they have nothing else to going on. A part-time trader may commit to trading three days a week, or to closing out at noon instead of at the close of the market. A successful part-time trader still has a business plan, still sets limits, and still acts like any professional trader would, just for a smaller part of the day. Part-time trading works best when the trader can set and maintain fixed business hours. Your brain knows when it needs to go to work and concentrate on the market, because the habit is ingrained. If you want to be a part-time day trader, approach it the same way that a part-time doctor, part-time lawyer, or part-time accountant would approach work. Find hours that fit your schedule and commit to trading during them. Have a dedicated office space with high-speed Internet access and a computer that you use just for trading. If you have children at home, you may need to have child care during your trading hours. And if you have another job, set your trading hours away from your work time. Trading via cell phone during your morning commute is a really good way to lose a lot of money (not to mention your life if you try it while driving).

Article / Updated 03-26-2016

Expected return, the happy number, has a not-so-happy counterpart called the probability of ruin. As long as there is some probability of loss, no matter how small, there is some probability that you can lose everything when you're trading. How much you can lose depends on how large each trade is relative to your account, the likelihood of each trade having a loss, and the size of the losses as they occur. The following figure shows the math for finding R, the probability of ruin. How to calculate the probability of ruin. A is the advantage on each trade. That’s the difference between the percentage of winning trades and the percentage of losing trades. In the earlier expected return example, trades win 60% of the time and lose 40% of the time. In that case, the trader’s advantage would be: 60% – 40% = 20% C is the number of trades in an account. Let’s assume that we’re dividing the account into ten equal parts, with the plan of making ten trades today. The probability of ruin today is 1.7%. Now, 1.7% isn’t a high likelihood of ruin, but it isn't zero, either. If your advantage is smaller, if the expected loss is larger, or if the number of trades is fewer, then the likelihood of ruin becomes even higher. The following table shows you the relationship between the trader’s advantage (the far left column), number of trades (along the top), and the corresponding probability of ruin, rounded to the nearest percentage. Probability of Ruin 1 2 3 4 5 6 7 8 9 10 2% 96% 92% 89% 85% 82% 79% 76% 73% 70% 67% 4% 92% 85% 79% 73% 67% 62% 57% 53% 49% 45% 6% 89% 79% 70% 62% 55% 49% 43% 38% 34% 30% 8% 85% 73% 62% 53% 45% 38% 33% 28% 24% 20% 10% 82% 67% 55% 45% 37% 30% 25% 20% 16% 13% 12% 79% 62% 49% 38% 30% 24% 18% 15% 11% 9% 14% 75% 57% 43% 32% 24% 18% 14% 10% 8% 6% 16% 72% 52% 38% 27% 20% 14% 10% 8% 5% 4% 18% 69% 48% 34% 23% 16% 11% 8% 5% 4% 3% 20% 67% 44% 30% 20% 13% 9% 6% 4% 3% 2% The bigger the edge and the more trades you can make, the lower your probability of ruin. Now, this model is a simplification in that it assumes that a losing trade goes to zero, and that’s not always the case. In fact, if you use stops (automatic buy and sell orders), you should never have a trade go to zero. But you can see steady erosion in your account that will make it harder for you to make money. Hence, probability of ruin is a useful calculation that shows whether you will lose money in the long run. The more trades you can make with your account, the lower your probability of ruin. That’s why money management is a key part of risk management.

Article / Updated 03-26-2016

Over the years, day traders have developed many different ways to manage their money. Most strategies are based on different statistical probability theories, and some share commonalities with casino gambling. The underlying idea is that you should never place all of your money in a single trade, but rather put in an amount that is appropriate given the level of volatility. Otherwise, you risk losing everything. Calculating position size under many of these formulas is tricky stuff. That’s why brokerage firms and trading software packages often include money management calculators. Martingale The martingale style of money management is common with serious casino gamblers, and many traders apply it as well. It’s designed to improve the amount of money you can earn in a game that has even odds. Most casino odds favor the house. Day trading, on the other hand, is a zero-sum game, especially in the options and futures markets. This means that for every winner, there is a loser, so the odds of any one trade being successful are even. The martingale system is designed to work in any market where the odds are even or in your favor. Under the martingale strategy, you start with a set amount per trade, say $2,000. If your trade succeeds, you trade another $2,000. If your trade loses, you double your next order (after you close or limit the first trade) so that you can win back your loss. (You may have heard gamblers talk about doubling down? Well, this is what they are doing.) Under the martingale system, you will always come out ahead as long as you have an infinite amount of money to trade. The problem is that you can run out of money before you have a trade that works. The market, on the other hand, has almost infinite resources because of the huge volume of participants coming and going all over the world. That means that you have an enormous disadvantage. As long as you have a disadvantage, thoughtful money management is critical. Monte Carlo simulation If you have the programming expertise or buy the right software, you can run what’s called a Monte Carlo simulation. In this, you enter in your risk and return parameters and your account value, let the program run, and it returns the optimal trade size. The system isn't perfect — it can’t incorporate every market situation that you’ll face, and it has the fractional trade problem that the other systems do. But it has one big advantage: It can incorporate random changes in the markets in ways that simpler money management models cannot. Monte Carlo simulation is not a do-it-yourself project unless you have extensive experience creating these programs. If you're interested, you need to find a suitable program. Two options are offered by AnalyCorp and Oracle Crystal Ball. Others are out there as well.