"Day Trading" refers to the practice of buying and selling financial instruments such as stocks, options, futures within the same trading day such that all positions will usually be closed before the market close of the trading day. This is also know as being flat at the end of the day. Traders that day trade are often referred to as day traders.

The more commonly day-traded financial instruments are stocks, stock options, currencies, and a host of futures contracts such as equity index futures, interest rate futures, and commodity futures.

Day trading used to be the sole and exclusive playground of the large financial firms and professional investors and speculators. Many day traders are bank or investment firms employees working as specialists in equity investment and fund management. However, day trading has become increasingly popular among home-based traders due to the rapid advances in computer technology, changes in legislation, and the popularity of the Internet.

Due to the high profits (and potential losses) that day trading can cause, day traders are sometimes referred to "gamblers" by other investors. However, for the knowledgeable and experienced day trader, the profits can be huge.

Although collectively called day trading, there are many sub-trading styles within the whole "day trading" tree. A day trader is not necessarily very active. Depending on one's trading strategy and style, the number of trades made in a day may vary from a few to hundreds.

Some day traders focus on very short or short-term trading, in which a trade may last seconds to a few minutes. They buy and sell many times in a day, trading very high volumes daily and therefore receiving big discounts from the brokerage.

Some day traders focus only on momentum or trend trading. They are more patient and wait for a ride on the strong move which may occur on that day. They make far fewer trades than the aforementioned traders.

Traditionally it is suggested day traders should always settle their positions before the market close of the trading day to avoid the risk of price gaps (differences between the previous day's close and the next day's open price) at the open. Some day traders consider this to be a golden rule to be obeyed at all times. However, some day traders believe it is acceptable to stay with a position after the market closes as long as it is still following a favorable trend.

Day traders often borrow money to trade. Since margin interests are typically only charged on overnight balances, the extra costs discourage them from holding positions overnight.

Due to the nature of financial leverage and the rapid returns that are possible, day trading can be extremely profitable, and high-risk profile traders can generate huge percentage returns. Some day traders manage to earn millions per year solely by day trading.

Nevertheless day trading can become very risky, especially if one has poor discipline, risk or money management. The common use of buying on margin (using borrowed funds) amplifies gains and losses, such that substantial losses or gains can occur in a very short period of time. In addition, brokers usually allow bigger margins for day traders. Where overnight margins required to hold a stock position are normally 50% of the stock's value, many brokers allow pattern day trader accounts to use levels as low as 25% for intra-day purchases. This means a day trader with the legal minimum $25,000 in his account can buy $100,000 worth of stock during the day, as long as half of those positions are exited before the market close. Because of the high risk of margin use, and of other day trading practices, a day trader will often have to exit a losing position very quickly, in order to prevent a greater, unacceptable loss, or even a disastrous loss, much larger than his original investment, or even larger than his total assets.

Even when a position has made a profit, the trader has to offset the transaction costs and the interest on the margin. It is commonly stated that 80-90% of day traders lose money. An analysis of the Taiwanese stock market suggests that "less than 20% of day traders earn profits net of transaction costs".

Originally, the most important U.S. stocks were traded on the New York Stock Exchange. A trader would contact a stockbroker, who would relay the order to a specialist on the floor of the NYSE. These specialists would each make markets in only a handful of stocks. The specialist would match the purchaser with another broker's seller; write up physical tickets that, once processed, would effectively transfer the stock; and relay the information back to both brokers. Brokerage commissions were fixed at 1% of the amount of the trade, i.e. to purchase $10,000 worth of stock cost the buyer $100 in commissions.

One of the first steps to make day trading of shares potentially profitable was the change in the commission scheme. In 1975, the Securities and Exchange Commission made fixed commissions illegal, giving rise to discount brokers offering much reduced commission rates.

The systems by which stocks are traded have also evolved, the second half of the twentieth century having seen the advent of Electronic Communication Networks (ECNs). These are essentially large proprietary computer networks on which brokers could list a certain amount of securities to sell at a certain price (the asking price or "ask") or offer to buy a certain amount of securities at a certain price (the "bid"). The first of these was Instinet. Instinet or "inet" (ECNs and exchanges are usually known to traders by a three- or four-letter designators, which identify the ECN or exchange on Level II stock screens) was founded in 1969 as a way for major institutions to bypass the increasingly cumbersome and expensive NYSE, also allowing them to trade during hours when the exchanges were closed. Early ECNs such as Instinet were very unfriendly to small investors, because they tended to give large institutions better prices than were available to the public. This resulted in a fragmented and sometimes illiquid market.

The next important step in facilitating day trading was the founding in 1971 of NASDAQ -- a virtual stock exchange on which orders were transmitted electronically. Moving from paper share certificates and written share registers to "dematerialize" shares, computerized trading and registration required not only extensive changes to legislation but also the development of the necessary technology: online and real time systems rather than batch; electronic communications rather than the postal service, telex or the physical shipment of computer tapes, and the development of secure cryptographic algorithms.

These developments heralded the appearance of "market makers": the NASDAQ equivalent of a NYSE specialist. A market maker has an inventory of stocks to buy and sell, and simultaneously offers to buy and sell the same stock. Obviously, it will offer to sell stock at a higher price than the price at which it offers to buy. This difference is known as the "spread". It is of no importance to the market-maker whether the price of a stock goes up or down, as it has enough stock and capital to constantly buy for less than it sells. Today there are about 500 firms who participate as market-makers on ECNs, each generally making a market in four to forty different stocks. Without any legal obligations, market-makers were free to offer smaller spreads on ECNs than on the NASDAQ. A small investor might have to pay a $0.25 spread (e.g. he might have to pay $10.50 to buy a share of stock but could only get $10.25 for selling it), while an institution would only pay a $0.05 spread (buying at $10.40 and selling at $10.35).

Trading Technology Improvements

In 1997, the SEC adopted "Order Handling Rules" which required market-makers to publish their best bid and ask on the NASDAQ. Another reform made during this period was the "Small Order Execution System", or "SOES", which required market makers to buy or sell, immediately, small orders (up to 1000 shares) at the MM's listed bid or ask. A defect in the system gave rise to arbitrage by a small group of traders known as the "SOES bandits", who made fortunes buying and selling small orders to market makers. The existing ECNs began to offer their services to small investors. New brokerage firms which specialized in serving online traders who wanted to trade on the ECNs emerged. New ECNs also arose, most importantly Archipelago (arca) and Island (isld). Archipelago eventually became a stock exchange and in 2005 was purchased by the NYSE (At this time, the NYSE has proposed merging Archipelago with itself, although some resistance has arisen from NYSE members). Commissions plummeted: in an extreme example (1000 shares of Google), in 2005 an online trader might buy $300,000 of stock at a commission of about $10, as opposed to the $3,000 commission he would have paid in 1974. Moreover, the trader would be able to buy the stock almost instantly and would get it at a cheaper price.

ECNs are in constant flux. New ones are formed, while existing ones are bought or merge. As of the end of 2006, the most important ECNs to the individual trader are Instinet (which bought Island in 2005), Archipelago (although technically it is now an exchange rather than an ECN), and The Brass Utility ("brut"), as well as the SuperDot electronic system now used by the NYSE.

The evolution of average NASDAQ share prices between 1994 and 2004This combination of factors has made day trading in stocks and stock derivatives (such as ETFs) possible. The low commission rates allow an individual or small firm to make a large numbers of trades during a single day. The liquidity and small spreads provided by ECNs allow an individual to make near-instantaneous trades and to get favorable pricing. High-volume issues such as Intel or Microsoft generally have a spread of only $0.01, so the price only needs to move a few pennies for the trader to cover his commission costs and show a profit.

The ability for individuals to day trade coincided with the extreme bull market in technical issues from 1997 to early 2000, known as the Dot-com bubble. From 1997 to 2000, the NASDAQ rose from 1200 to 5000. Many naive investors with little market experience made huge profits buying these stocks in the morning and selling them in the afternoon, at 400% margin rates.

Adding to the day-trading frenzy were the enormous profits made by the "SOES bandits". (Unlike the new day traders, these individuals were highly-experienced professional traders able to exploit the arbitrage opportunity created by SOES.)

In March, 2000, this bubble burst, and a large number of less-experienced day traders began to lose money as fast, or faster, than they had made during the buying frenzy. The NASDAQ crashed from 5000 back to 1200; many of the less-experienced traders went broke.

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