Top 10 Day Trading Strategies for Beginners Part 2
Before we go into some of the ins and outs of day trading, let's look at some of the reasons why day trading can be so difficult.
What Makes Day Trading Difficult?
Day trading takes a lot of practice and know-how, and there are several factors that can make the process challenging.
First, know that you're going up against professionals whose careers revolve around trading. These people have access to the best technology and connections in the industry, so even if they fail, they're set up to succeed in the end. If you jump on the bandwagon, it means more profits for them.
Uncle Sam will also want a cut of your profits, no matter how slim. Remember that you'll have to pay taxes on any short-term gains—or any investments you hold for one year or less—at the marginal rate. The one caveat is that your losses will offset any gains.
As an individual investor, you may be prone to emotional and psychological biases. Professional traders are usually able to cut these out of their trading strategies, but when it's your own capital involved, it tends to be a different story.
Deciding What and When to Buy
Day traders try to make money by exploiting minute price movements in individual assets (stocks, currencies, futures, and options), usually leveraging large amounts of capital to do so. In deciding what to focus on—in a stock, say—a typical day trader looks for three things
- Liquidity: Liquidity allows you to enter and exit a stock at a good price. For instance, tight spreads or the difference between the bid and ask price of a stock, and low slippage or the difference between the expected price of a trade and the actual price.
- Volatility: Volatility is simply a measure of the expected daily price range—the range in which a day trader operates. More volatility means greater profit or loss.
- Trading volume: This is a measure of how many times a stock is bought and sold in a given time period—most commonly known as the average daily trading volume. A high degree of volume indicates a lot of interest in a stock. An increase in a stock's volume is often a harbinger of a price jump, either up or down.
Once you know what kind of stocks (or other assets) you're looking for, you need to learn how to identify entry points—that is, at what precise moment you're going to invest. Tools that can help you do this include:
- Real-time news services: News moves stocks, so it's important to subscribe to services that tell you when potentially market-moving news comes out.
- ECN/Level 2 quotes: ECNs, or electronic communication networks, are computer-based systems that display the best available bid and ask quotes from multiple market participants and then automatically match and execute orders. Level 2 is a subscription-based service that provides real-time access to the Nasdaq order book composed of price quotes from market makers registering every Nasdaq-listed and OTC Bulletin Board security. Together, they can give you a sense of orders being executed in real time.
- Intraday candlestick charts: Candlesticks provide a raw analysis of price action. More on these later.
Define and write down the conditions under which you'll enter a position. "Buy during uptrend" isn't specific enough. Something like this is much more specific and also testable: "Buy when price breaks above the upper trendline of a triangle pattern, where the triangle was preceded by an uptrend (at least one higher swing high and higher swing low before the triangle formed) on the two-minute chart in the first two hours of the trading day."
Once you have a specific set of entry rules, scan through more charts to see if those conditions are generated each day (assuming you want to day trade every day) and more often than not produce a price move in the anticipated direction. If so, you have a potential entry point for a strategy. You'll then need to assess how to exit, or sell, those trades.
Deciding When to Sell
There are multiple ways to exit a winning position, including trailing stops and profit targets. Profit targets are the most common exit method, taking a profit at a pre-determined level. Some common price target strategies are:
|Scalping||Scalping is one of the most popular strategies. It involves selling almost immediately after a trade becomes profitable. The price target is whatever figure that translates into "you've made money on this deal."|
|Fading||Fading involves shorting stocks after rapid moves upward. This is based on the assumption that (1) they are overbought, (2) early buyers are ready to begin taking profits and (3) existing buyers may be scared out. Although risky, this strategy can be extremely rewarding. Here, the price target is when buyers begin stepping in again.|
|Daily Pivots||This strategy involves profiting from a stock's daily volatility. This is done by attempting to buy at the low of the day and sell at the high of the day. Here, the price target is simply at the next sign of a reversal.|
|Momentum||This strategy usually involves trading on news releases or finding strong trending moves supported by high volume. One type of momentum trader will buy on news releases and ride a trend until it exhibits signs of reversal. The other type will fade the price surge. Here, the price target is when volume begins to decrease.|
In most cases, you'll want to exit an asset when there is decreased interest in the stock as indicated by the Level 2/ECN and volume. The profit target should also allow for more profit to be made on winning trades than is lost on losing trades. If your stop loss is $0.05 away from your entry price, your target should be more than $0.05 away.
Just like your entry point, define exactly how you will exit your trades before entering them. The exit criteria must be specific enough to be repeatable and testable.
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