Day trading involves buying and selling (or first short selling and then buying back) an instrument with an aim at making a quick profit. The holding duration may vary from a few seconds to a few hours but not exceed the span of a trading day. For example, a speculative trader may spot a technical uptrend in Microsoft Corporation stock (MSFT) at 10:15 a.m., take a long position and square it off in 45 minutes for a quick profit.
A carry-over of the position to another day does not qualify as day trading. By its nature, day trading requires quick and timely action by a trader, usually in higher values that cover the thin profit margins. Overall, small profits on large volumes give day traders an acceptable profit. Most day trading occurs on margin, allowing traders with limited capital to take large positions that equal many times their trading capital. The large volume also ensures lower transaction costs.
Multiple tradable assets are available in the global markets, including stocks, bonds, forex, commodities, and various derivative instruments on those (like futures, options, or swaps). When it comes to short-term trading, a few assets tend to outperform the others.
How To Choose Stocks For Day Trading
Criteria for Day Trading
Which instruments are best for day trading? Let’s start by looking at a few basic characteristics that fit the day trading criteria:
- High liquidity: Ease of buying and selling in large amounts smoothens trading and ensures price fairness and efficiency.
- High volatility: High volatility is a friend if one wants to trade frequently with an aim to generate profits multiple times. Not just for pricing of plain vanilla financial products like equities and bonds, volatility plays a pivotal role in pricing other popular products like options.
- Low transactional costs: Frequent trading should not lead to high transactional costs. Brokers offer staggered brokerage charges wherein the per unit trading cost lowers as one trades in higher volumes. Low costs are a must for any day trading activity.
- Margin trading/leverage: No trader would trade actively and frequently if they have to hold large amounts of trading capital. The inherent benefit of leverage is that it allows traders to trade higher proportions with limited capital. A low capital requirement leads to a high level of trading activities in the overall market. However, leveraged or margin trading is a double-edged sword that offers exposure on both profit and loss side. Care should be taken to keep trading within cautious limits.
- Availability of information: Markets move on news, and day traders keep a close eye for information on assets they trade on. Not all brokers and trading platforms provide easy and quick access to associated news on all instruments. Add-ons like text alerts on mobile devices may remain restricted to a qualified list of instruments (e.g. top 30 or top 100). Easy availability of news and associated features become “good-to-have” parameters when selecting day trading instruments.
Day Trading Instruments
Let’s see which instruments fit the above criteria for qualifying as the best fit for day trading:
Foreign currency exchange markets run 24/7 and forex instruments fit perfectly for short-term day trading as they offer high volatility, large liquidity, low capital requirements, and low transactional costs. However, care should be taken to select an apt currency pair that matches the needs of day trading.
Exotic currency pairs should be avoided as they lack the liquidity parameter. Most forex day trading happens through near-term forex futures, closely followed by forex options, forex spot trading, and forex binary options trading. Day traders should select the ones they are familiar with and that fit their desired trading strategy.
One of the most liquid and high-volume trading instruments is futures on popular indices like the Standard & Poor’s. Index futures are highly liquid and come with low transaction costs, but they are less volatile. Day traders familiar with futures trading benefit from the high leverage available on index futures trading.
Futures on highly-liquid commodities like crude oil and gold make them good instruments for day trading. Day trading in commodity futures also offers a diversification of assets from the usual equity or index-based trading.
Options on indexes (and volatile stocks)
Options offer low-cost alternatives to costly stocks. Carefully-selected option positions (or option combinations) on highly-tracked indices and popular stocks with high volatility are suitable day trading instruments due to their high liquidity, high volatility, and low capital requirements. However, they usually come with high transaction costs.
Exchange-traded funds (ETFs) are gaining popularity as one of the most efficient investment classes. These ETFs are good not only for long-term investors, but also day traders, because of their high liquidity and the low cost of trading. Carefully selected ETFs on common indexes like the S&P 500 or commodities like gold are the best bets for day traders.
Bonds may not be the best trading instruments for day trading due to the high capital requirement. However, bond futures offer high liquidity, high volume, very low transaction costs, and high leverage due to their lower risk profile. More importantly, day trading in bond futures offers much-needed diversification for traders (depending upon the overall economic cycle).
In all of the futures and options trading based on different underlying assets, the availability of a mini-contract series offers the best combination of low contract size requiring low capital investment and high volume. Beginners exploring day trading during their learning phase can start with the mini-series contracts.
The Bottom Line
Day trading is an exciting and intense activity, which often attracts beginners. However, it comes with its own considerations. No financial instrument should be picked for trading unless the trader has developed sufficient knowledge and familiarity with its characteristics. Trading an instrument just because it is on the top of a trading list is a sure sign of failure if the trader does not have basic knowledge of that instrument.
Traders should carefully study and familiarize themselves with the basics and the realistic possibility of profitability before commencing day trading with any instrument.