Day trading

From Traderpedia

A trading style in which positions are opened and closed in the space of one day or less.


[edit] Trade Frequency

Some day traders are scalpers making tens, perhaps even hundreds of round trips per day, while others will trade less frenetically, perhaps making just one or two trades per day to catch the major swings. This latter approach is sometimes called momentum trading.

[edit] Requirements

  • Knowledge of technical analysis.
  • Knowledge of the different types of market participants and their aims.
  • Personal discipline, patience and objectivity.
  • A sound, proven, consistent methodology.
  • Real time data provision, fast execution, low commissions and spreads.

[edit] Advantages

  • Potential for excellent return on capital. 1% per day is realistic.
  • No overnight event risk.
  • Knowledge of fundamental analysis not required.
  • Can trade on margin from a small capital base (although US stock day traders will require $25,000 minimum capital thanks the the ridiculous "pattern day trading" rule imposed by the US).
  • Huge number of instruments to trade and platforms with which to trade them.

[edit] Disadvantages

  • High cost of doing business per unit of profit.
  • Labour intensive, intellectually and emotionally demanding. Steep learning curve.
  • Does not suit all personalities.
  • Extremely competitive; low odds of consistent returns.

[edit] Day Trading Strategy

[edit] Do I need a strategy?

A well-defined strategy is essential in day trading. Without a specific methodology, traders are vulnerable to making impulsive decisions based on little more than a whim, or perhaps from fear or greed. Emotions cannot be allowed to affect the day trader, and one who does not have a specific plan is extremely vulnerable to their influence. The strategy has to specify when to get in and when to get out of a position. Every step that a trader must take has to be spelled out because generalities in day trading are a disaster waiting to happen. a

[edit] Trading is a harsh business

70% to 90% of day traders lose money. Day trading is a business, not a game, and one of the harshest most competitive businesses in existence to boot. Many small businesses are formed every year, yet statistics say that about 80% of them go bankrupt in their first two years of existence. Why is this? Because most new entrepreneurs are not properly equipped to run the operations they start. Whether it is due to a lack of enough practical experience or a lack of understanding of the risks and inner workings of the business, many are not prepared to succeed. They start a business out of impulse, thinking only about the great potential rewards that lie ahead. Since day trading is a business too, most people that start doing it also fail to prepare themselves properly before beginning. Without learning and practicing the proper techniques and methodologies required to succeed as a day trader, most day traders simply become another small business statistic.

[edit] Objective and subjective

So what kind of strategy do I need to learn to day trade, you ask? There are many out there. You are constantly being bombarded by internet, TV, and print advertising from gurus that want to sell you their "secret" trading system. Since most people are looking for shortcuts ("secrets") all the time, they wind up buying these magical systems or courses, sometimes spending thousands of dollars in the process. Eventually, they find out the hard way that these secret methods don't work and give up day trading altogether. The reality is that there are many different strategies that day traders can use that might work. What is important is that the strategy is well defined and is as objective as possible.

In other words "if this specific condition happens, then take this specific action" (objective analysis), rather than, "analyse the market and get a feel for it before placing your order" (subjective analysis). The great majority of people that use a subjective strategy, wind up making the wrong decision or staying in a trade too long because they reach a "logical" conclusion, but the market acts "illogically". Many of these "logical" strategy traders try to determine where the market is going, instead of reacting to what the market IS doing.

Purely objective strategies tend to be mechanical with fixed rules for entry and exit. Some traders will allow some discretion into their methodology so that, although the entry and exit rules may be mechanical, the signals will not always be taken and position size may vary according to what degree the trader thinks the signal is valid.

For instance, a trader might trade a breakout of the first 30 minutes' high/low range of the Dow Jones futures. This is the mechanical criterion. However, (s)he might also use discretion to avoid trading this breakout, if, say, some very important news was due at the end of the 30 minutes that might cause wild price action.

At the highest levels of trading, it is possible to view market action objectively, untainted by the emotions that affect nearly all traders to some degree, and use little more than intuition, experience and a mental stop loss to make entirely discretionary, successful trades, but this is not advisable until you have an absolutely superb knowledge of the nuances of market action and supreme personal knowledge.

[edit] What are the components of a strategy?

  1. Entry and exit signal
  2. Stop loss placement
  3. Money management, including position sizing

Remember that these three sections of a strategy have to be as specific as possible and they have to make sense. A day trader cannot be thinking in the middle of a trade, "Where will I place my stops this time?" or "I wonder if I should be buying or selling now?" This has to be clearly defined by the system being used so that the day trader is simply following a set of conditions in any given market situation. When this is accomplished, every new position that the trader enters or exits builds the discipline he needs to succeed.

Mastery of the day trading strategy will come over time, as the trader learns to apply it with precision and consistency. That is why it is also important that the strategy be simple enough to apply without having a Ph.D. from MIT. When the strategy has too many indicators and conditions, the day trader can be easily confused, and a confused trader has almost no chance of executing successful trades.

A successful strategy must boast a postive expectancy.

[edit] Tools of the trade

There are an infinite number of ways to generate trading signals as part of a system. Day traders tend to rely almost exclusively on technical analysis of which there are many components. Some of the most common systems take their signals from one or more of the following:

A day trader should have a number of strategies in order to account for different market conditions. For instance, one which capitalises on trends and another which works in consolidations.

[edit] See also

[edit] T2W links