Investing in stocks and holding them for many years is a common way to build wealth for retirement, but some investors buy and sell stocks every day. These day traders take advantage of the fact the stock market has no rules covering how many times or when a stock can be exchanged. That means you can get a stock in the morning and sell it that afternoon -- if you want to wait even that long.
Day Trading Basics
Day trading is, in fact, a well-established stock buying strategy. Day traders attempt to buy stocks when their prices are low, and quickly sell them as soon as the prices look like they're going up. According to an article posted on the U.S. Securities and Exchange Commission's official website on April 2005, a day trader can buy and sell a stock in just a few seconds.
Regular day trading is closer to gambling than it is to investing. Day traders essentially place bets on what a stock price will do on that given day instead of studying long-term stock market trends. Stock prices are nothing if not unpredictable, which makes day trading an extremely risky practice. Day traders typically suffer severe financial losses in their first months on the stock floor, and some never manage to make a profit.
Fees and Taxes
Even if you're not a dedicated day trader, it can be costly to make a lot of trades in a short time. Stock brokerage firms typically charge transaction fees for each trade an investor makes. Besides that, if you have profits on any investment you hold for a year or less, you'll get hit with short-term capital gains tax. That tax is equal to your normal income tax rate, which could be as high as 35 percent, while the long-term capital gains rate is capped at 15 percent.
Using an online stock trading service to engage in single-day trades carries several risks. Online trades may not be processed instantaneously. In some cases, Internet traffic and other problems may cause trades to fail. Quick transactions help day traders sell stocks when prices are up to reap gains.
Pattern Day Traders
The government does place a few restrictions on frequent day traders. If you make more than three day trades within five business days, you're considered a "pattern day trader." As a pattern day trader, you need to keep at least $25,000 in your investment account. If your account falls below that level you won't be permitted to day trade.
- U.S. Securities and Exchange Commission: Day Trading
- U.S. Securities and Exchange Commission: Day Trading: Your Dollars at Risk
- Internal Revenue Service: Topic 409 - Capital Gains and Losses
- Internal Revenue Service: Ten Important Facts About Capital Gains and Losses
- U.S. Securities and Exchange Commission: What You Need to Know About Trading In Fast-Moving Markets
- Financial Industry Regulatory Authority
- U.S. Securities and Exchange Commission: Margin Rules for 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.