Day Trading Strategies

Day Trading Strategies

A trader needs to have an edge over the rest of the market. Day traders use any of a number of strategies, including swing trading, arbitrage, and trading news. They refine these strategies until they produce consistent profits and limit their losses.

There also are some basic rules of day trading that are wise to follow: Pick your trading choices wisely. Plan your entry and exit points in advance and stick to the plan. Identify patterns in the trading activities of your choices in advance.

Discipline

Many day traders end up losing money because they fail to make trades that meet their own criteria. As the saying goes, “Plan the trade and trade the plan.” Success is impossible without discipline.

To profit, day traders rely heavily on market volatility. A day trader may find a stock attractive if it moves a lot during the day. That could happen for a number of different reasons, including an earnings report, investor sentiment, or even general economic or company news.

Day traders also like stocks that are highly liquid because that gives them the chance to change their position without altering the price of the stock. If a stock price moves higher, traders may take a buy position. If the price moves down, a trader may decide to sell short so they can profit when it falls.

Regardless of what technique a day trader uses, they’re usually looking to trade a stock that moves (a lot).

Who Makes a Living by Day Trading?

There are two primary divisions of professional day traders: those who work alone, and/or those who work for a larger institution.

Most day traders who trade for a living work for large players like hedge funds and the proprietary trading desks of banks and financial institutions. These traders have an advantage because they have access to resources such as direct lines to counterparties, a trading desk, large amounts of capital and leverage, and expensive analytical software.

These traders are typically looking for easy profits from arbitrage opportunities and news events. Their resources allow them to capitalize on these less risky day trades before individual traders can react.

The Solo Day Traders

Individual traders often manage other people’s money or simply trade with their own. Few have access to a trading desk, but they often have strong ties to a brokerage due to the large amounts they spend on commissions and access to other resources.

However, the limited scope of these resources prevents them from competing directly with institutional day traders. Instead, they are forced to take more risks. Individual traders typically day trade using technical analysis and swing trades—combined with some leverage—to generate adequate profits on small price movements in highly liquid stocks.3

Day trading demands access to some of the most complex financial services and instruments in the marketplace. Day traders typically require all of the following:4

Access to a Trading Desk

This is usually reserved for traders who work for larger institutions or those who manage large amounts of money.

The trading or dealing desk provides these traders with instantaneous order execution, which is crucial. For example, when an acquisition is announced, day traders looking at merger arbitrage can place their orders before the rest of the market is able to take advantage of the price differential.

Multiple News Sources

News provides most of the opportunities. It is imperative to be the first to know when something significant happens.

The typical trading room has access to all of the leading newswires, constant coverage from news organizations, and software that constantly scans news sources for important stories.  

Analytical Software

Trading software is an expensive necessity for most day traders. Those who rely on technical indicators or swing trades rely more on software than on news. This software may be characterized by the following:

• Automatic pattern recognition: This trading program identifies technical indicators like flags and channels, or more complex indicators such as Elliott Wave patterns.
• Genetic and neural applications: These programs use neural networks and genetic algorithms to perfect trading systems and make more accurate predictions of future price movements.
• Broker integration: Some of these applications even interface directly with the brokerage, allowing for instantaneous and even automatic execution of trades. This eliminates emotion from trading and improves execution times.
• Backtesting: This allows traders to look at how a certain strategy would have performed in the past to predict more accurately how it will perform in the future. Keep in mind that past performance is not always indicative of future results.

Combined, these tools provide traders with an edge over the rest of the marketplace.

Risks of Day Trading

For the average investor, day trading can be a daunting proposition because of the number of risks involved. The U.S. Securities and Exchange Commission (SEC) highlights some of the risks of day trading, which are summarized below:

• Be prepared to suffer severe financial losses: Day traders typically suffer severe financial losses in their first months of trading, and many never make a profit.
• Day trading is an extremely stressful full-time job: Watching dozens of ticker quotes and price fluctuations to spot fleeting market trends demands great concentration.
• Day traders depend heavily on borrowing money: Day-trading strategies use the leverage of borrowed money to make profits. Many day traders not only lose all of their own money, they wind up in debt.
• Don’t believe claims of easy profits: Watch out for hot tips and expert advice from newsletters and websites catering to day traders and remember that educational seminars and classes about day trading may not be objective.5
  

Should You Start Day Trading?

If you're determined to start day trading, be prepared to commit to the following steps:6

• Make sure you come in with some knowledge of the trading world and a good idea of your risk tolerance, capital, and goals.
• Be prepared to put in the time to practice and perfect your strategies.
• Start small. Focus on a few stocks rather than wearing yourself thin. Going all out will complicate your trading strategy and can mean big losses.
• Stay cool and try to keep emotion out of your trades. Don't deviate from your plan.

If you follow these simple guidelines, you may be headed for a sustainable career in day trading.

Day Trading Example

A day trade is exactly the same as any stock trade except that both the purchase of a stock and its sale occur within the same day, and sometimes within seconds of each other.

For example, say a day trader has completed a technical analysis of a company called Intuitive Sciences Inc. (ISI). The analysis indicates that this stock, which is listed in the Nasdaq 100, shows a pattern of rising in price by at least 0.6% on most of the days when the NASDAQ is up more than 0.4%. The trader has reason to believe that this is going to be one of those days.

The trader buys 1,000 shares of ISI when the market opens, then waits until ISI reaches a particular price point, probably up 0.6%. The trader then immediately sells the entire holding in ISI.

This is a day trade. Obviously, the merits of ISI as an investment have nothing to do with the day trader's actions. A trend is being exploited.

What if ISI had bucked the trend and lost 0.8%? The trader will sell anyway and take the loss.

How Do I Get Started Day Trading?

A successful day trader understands the discipline of technical analysis. This is identifying trading opportunities by observing and plotting the patterns of price and volume movement in a stock (or any other investment). The long-term trend shows how the stock has behaved in the past and suggests how it should behave in the immediate future.

Technical analysis is not usually done with paper and pencil these days. There are software packages that help create charts and graphs for the purpose.

The day trader also must have a plan in place before making a single trade. Which stocks to trade and what price points are acceptable for buying and selling all must be set in advance. A successful day trader does not leave room for impulse purchases.

Finally, even a solo day trader must have a trading desk, fully equipped with the news services, real-time data, and brokerage services needed to carry out the plan.

If you're going to trade on margin you'll also need a lot of cash on deposit with the broker. This is not recommended for a beginner as it carries a high risk that the trader will wind up broke and deep in debt.

Much better to start out with whatever amount of cash you can afford to lose.