Daily Trading Strategy — What Is It? (Backtest)

Last Updated on August 28, 2022 by Oddmund Groette

Some active traders like to trade daily, opening and closing their trades within the trading day. This manner of trading requires having a daily trading strategy.

The daily trading strategy is a method of trading where a trader buys and sells a financial instrument within the same trading day all positions are closed before the market closes for the trading day. The daily trading strategy aims to exploit the inevitable up-and-down price movements that occur during a trading day while avoiding unmanageable risks and negative price gaps that may occur between one day’s close and the next day’s price at the open.

In this post, we take a look at this trading approach and the rules.

What is daily trading?

Daily trading refers to a method of trading where a trader buys and sells a financial instrument within the same trading day — the trader closes all positions before the market closes for the trading day. The daily trading strategy aims to exploit the inevitable up-and-down price movements that occur during a trading day while avoiding unmanageable risks and negative price gaps that may occur between one day’s close and the next day’s price at the open.

This manner of trading is considered speculation; some even call it gambling, in contrast with the long-term investors who often buy and hold their investments for a long time. Daily trading is most common in Forex and futures trading, but it is also very popular in the stock markets. Day traders often use leverage to increase the size of their stakes. As a result, they can use a small amount to open a huge position, especially in Forex and futures. However, for daily trading in the US stock market, you have to be well funded to meet the pattern day trading rules.

Day trading rules

There are rules that govern day trading in the US stock market, known as the pattern day trading rules, which were put in place by the Financial Industry Regulatory Authority (FINRA), the self-regulatory organization that regulates member brokerage firms and exchange markets in the US.

What are the pattern day trading rules?

The FINRA designates a pattern day trader as one who executes four or more “day trades” within five business days — as long as the number of day trades represents more than six percent of your total trades in the margin account for that same five business day period.

According to the rules, your broker can also designate you as a pattern day trader if it knows or has a reasonable basis to believe that you will engage in pattern day trading. For instance, if the broker provided day-trading training to you before opening your account, it could designate you as a pattern day trader and will continue to regard you as a pattern day trader even if you do not day trade for a five-day period. As long as the broker has a “reasonable belief” that you are a pattern day trader based on your prior trading activities, you are regarded as one and must abide by the requirements. So, if you change your trading strategy and no longer engage in day trading activities, you have to contact your broker to change the pattern day trading designation on your account.

Pattern day trading requirements

As a pattern day trader, you are required to maintain minimum equity of $25,000 in your margin account on any day that you day trade. This minimum equity can be a combination of cash and eligible securities but must be in the trading account before engaging in any day-trading activities. Any time your account falls below the $25,000 requirement, you will not be permitted to day trade until you restore your account to the $25,000 minimum equity level.

In addition to the maintenance margin requirement, you cannot exceed your day-trading buying power — which is generally up to four times the maintenance margin excess as of the close of trading the day before. This maintenance margin excess is the amount by which the equity in the margin account exceeds the required margin. To put it differently, you are only allowed up to 4x leverage.

Why do you have to maintain minimum equity of $25,000?

The reason is that day trading can be extremely risky — both for you and the brokerage firm that clears your transactions. Although you don’t have open positions by the close of the trading day, the trades you made during the market hours have not yet been settled. So, the day trading margin requirements offer the broker the necessary cushion to meet any deficiencies in your account resulting from day trading.

How to by-pass the pattern day trader requirement

You can still day trade the US stock market without meeting FINRA’s pattern day trading rules. One way to do that is to trade stock CFDs through online CFD brokers that offer US stock. A stock CFD is a contract between you and the broker to exchange the difference in the price of a stock between the time you open a trade and the time you close it. Note that stock CFDs don’t give you ownership of the stocks, but as a day trader, you are only interested in the price movements of the day, not owning the stock. Ensure you trade with a reliable and well-regulated CFD broker.

Another way to day-trade US stocks without restrictions is to trade stock options via some day trading platforms like Robinhood. With stock options, you don’t need to maintain a $25,000 margin on your trading account. All you need is your premium and the capital to buy or sell your stock at the strike price.

Day trading for beginners

Day trading is very difficult for experienced traders, let alone beginners. Yet, many new retail traders are rushing into day trading because they think it offers a quick way to riches. While day trading can be potentially profitable, it requires a lot of hard work.

As a beginner, you must focus on learning how the market works first. You can learn on your own, but it would take you years to achieve an optimal level of knowledge. A faster way is to get a mentor who can guide your learning process.

It is important to focus on using quantified strategies. So, you have to learn how to research the market to find trading edges and how to create and back-test strategies. Knowing the timeframe you want to trade is very important. For day trading, it has to be from the hourly timeframe to lower ones like the 15-minute and 5-minute timeframes.

After learning how the market works and how to develop and test strategies, most of your learning would be practicing on a demo account. This way, you can master your broker’s platform and how to manage your trades. Don’t forget risk management and the right way to use leverage. Improper use of leverage can destroy the chances of an otherwise beautiful strategy.

What percentage of day traders make money?

Only a few traders make money from day trading. We have looked at plenty of research and very few retail traders can brag about making any significant amount of money day trading. Evidence shows that only about 1-20% of day traders make money day trading. In other words, between 80 to 99% of day traders fail. Proprietary traders seem to fare better than retail traders. This is expected because they treat day trading as a business. However, many prop traders fail miserably too, only about 16-42% make money.

But the question is why do many day traders fail? Well, from our findings, the reason is that they don’t understand the ecology of the markets, have no game plan, trade too big, don’t know their risk tolerance, and most importantly, don’t use quantified strategies. Trading without a quantifiable trading edge, which most day traders do, is just like making a blind guess.

How to succeed in daily trading

To increase your chances of succeeding in day trading, here are the things you can do:

  • Learn from a profitable mentor: You stand a chance if you can learn from who understands the market and knows what they are doing. The problem is that profitable traders are busy researching and making money and have little time for mentoring.
  • Do your research: Study the market you want to trade extensively and look to find an edge.
  • Back-test your strategies: Only quantified strategies can make you money. So, make sure you back-test your strategies.
  • Use a demo account first: Demo trading is a good way to start. You get to implement your back-tested strategy to see how it performs in the current market condition.
  • Start small: When going live, start with a small amount first to be sure you can tolerate the risk.
  • Keep a trading journal: Ensure you record all trades so you can later go through them to see how you can improve your results. This allows you to learn from your mistakes.
  • Subscribe to a trading signal service: If you don’t have time to analyze the markets and create your own strategies, you can subscribe to a trading signal service like The Robust Trader.

Daily trading strategy (backtest and example)

A backtest of a daily trading strategy is coming soon.

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