Day trading is the practice of holding positions in a financial market for no longer than a single day, and often for much shorter periods of time. Day traders always exit any trade before the end of the trading day (often referred to as the ‘regular cash session’), and aim to profit from the accumulation of lots of small wins, rather than swinging for large gains over a longer time horizon as most investors do.
Although day trading has many similarities to other more long term approaches to the markets, and similar strategies are often employed in shorter timeframes using instruments such as futures, when it comes to choosing a broker for day trading there are some significant differences. Understanding these and choosing both the right trading instrument and the right online brokerage firm can be crucial to your success as a day trader.
The reason for this is somewhat technical, but important to understand; it hinges upon the difference between fixed costs and variable trade profits.
As a trader of any kind, you’ll have an average profit per trade. Assuming you’re profitable, then this figure will be positive. However, there will be a considerable difference between the average trade profit of a day trader versus a long term investor.
This has absolutely nothing to do with the success of the trader or their ability to identify profitable opportunities, it’s simply a function of time. The longer the period of time, the more price will typically move. If you hold a position for a week, then price has the opportunity to move much further (whether in your favor or against you) than if you only hold the position for a minute. Even if every single trade is profitable for a trader that only holds positions for a minute, then their average profit per trade will be small – price simply doesn’t move very far in a minute.
So, the average profit per trade varies according to time, and the average profit per trade of a day trader will typically be much lower than that of a longer term trader. This is regardless of whether you’re trading stocks, options, forex, futures, or any other market.
What doesn’t vary, on the other hand, are the fixed costs associated with trading. Depending on your choice of broker and the instrument you trade, these can include all of the following:
- Commission Spread Exchange Fee Slippage Financing for Margin Financing for Short Sales
Whether you happen to be buying a futures contract or shorting a stock, the costs will be the same regardless of whether you hold that position for a few minutes or a few months.
This creates a situation where the day trader has exactly the same fixed costs as the longer term trader, but a much lower average profit per trade. In fact, the day trader needs to achieve a modest profit just in order to cover his or her fixed costs and break even.
Let’s study a quick example to see how this works . . . Suppose that a trader buys a single futures contract. He pays a spread of $12.50, exchange fees and commission of $5, and experiences a tick of slippage when he enters his position, also costing him $12.50. His total trading costs are $30. That means that his position needs to achieve a profit of $30 just to break even. If the market he’s trading typically only moves $30 in 15 minutes, and he always exits his positions after 15 minutes, then if he would need for 100% of his trades to be winners just in order to break even.
Does this make day trading a futile enterprise? Certainly not. If the trader hold positions for 30 minutes (in which the market moves $60 on average) then his chances improve considerably: if anything more than 75% of his trades are winners then he will overcome his fixed costs and achieve a profit. Average profits per trade rise, and fixed costs per trade remain the same.
What does all this mean when it comes to choosing a broker for day trading?
Minimizing fixed costs needs to become an absolute priority for short term traders, and low commissions and spreads are something that must factor heavily in the choice of broker. After ensuring that the broker is registered with the regulator and compliant, keeping brokerage costs to a minimum will need to become the top priority, and should be given more significant attention than charting platforms, range of markets, and other features.