Inside
the Day Trading Revolution
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Day Trading Strategies and Concepts
Any discussion about trading strategies
should be prefaced by a reminder that no matter how learned
and experienced you become, there will always be a significant
element of uncertainty that accompanies your decisions. The
market is fickle and unpredictable. Rules are not always followed
and expectations are not always realized - in spite of conventional
wisdom. No one can consistently predict with any degree of
accuracy what path the market will follow over a period of
time. This is particularly true of the short-term.
While it is true that the market
has shown consistent growth in recent years, no one can say
how long that trend will last. Few expect that it will last
indefinitely.
Consider the following question
once posed to a financial sage:
"Will the market go up
or down?"
His answer was simple and telling:
"Yes."
With that in mind, the following
are meant as informational guidelines for would-be day traders.
Good luck!
Buy low; sell high.
This is first rule of investment
and it seems so obvious that it hardly merits repeating. You
would be surprised, however, at the number of investors and
traders that lack the discipline to consistently adhere to
this first law of investment. It takes patience, perseverance,
stamina and hard work to live by this law. It is critical
that you develop the mindset early on that your overriding
objective is to make money. Then never lose sight of the fact
that the only way to do this is to consistently sell at higher
prices than you pay.
Watch for opportunities to make
money countering big price movements.
Dramatic price moves - up or down
- will frequently be followed by mild to modest corrections.
This can spell opportunity for the astute trader who is willing
to go counter to the prevailing trend. This theory holds that
you should buy after investors have unmercifully beaten a
stock down to an unreasonable level and sell after a major
run-up to a questionable height. Be careful, however, to understand
what is driving the price change - particularly on the downward
side. If the potential exists for more bad news, the downward
run may be just beginning. A good way to gauge this is by
watching the trading volume. As selling volumes begin to diminish,
it is often a signal that the price is bottoming out.
Don't trade with money you are
not willing to lose.
Day trading can be an extremely
risky proposition. You would be well advised to avoid trading
with capital that is not disposable. Much heartache can be
avoided by adhering to this one principal.
Preserve your trading capital.
Avoid extremely large and risky
trades that jeopardize your capital base. Betting big is nice
when you win but it can be devastating when you lose. Most
successful day traders remain successful by sticking to a
proven strategy of quickly executing a larger number of small
to medium sized trades. They settle for reasonable profits
and limit themselves to minimal losses by getting out of losing
positions quickly. This requires a lot of consistent effort
and discipline, but it is a strategy that reduces risk in
the face of uncertainty and one that preserves your capital
base. If you lose a large piece of your capital base, your
trading capability will be severely diminished going forward.
Don't get greedy.
Take your profits and move on. Holding
a winning position for too long in anticipation of maximizing
your gain is more often than not a bad idea. It is better
to bankroll a respectable gain and get out a little early
than to watch as your entire gain is erased by profit taking
activity.
Minimize losses by knowing when
to get out of a losing position.
Stick to your strategy but be willing
to admit quickly to mistakes and get out of a losing position.
Trying to justify a bad decision is a poor strategy. You cannot
afford to become emotionally attached to a transaction. Even
if you know in your heart of hearts that the stock should
have gone up when it went down, you may be better served to
cut your losses and move on. Riding a losing stock down can
be a gut wrenching and devastating experience. Don't take
it personally when the market moves against you. And do not
be dismayed when the market does not behave the way you believe
it will. Stick to your strategy and remember that market fundamentals
do not necessarily drive short-term price swings.
Understand the spread on a stock
before trading in it.
There can be a significant difference
between the Ask Price (what you pay for a stock) and the Bid
Price (what you can sell the stock for). If the spread between
Bid and Ask is large, it is easy to get the false sense that
you are making money on the stock because the price is going
up - when you really aren't. Be careful. This is one of the
greatest risks of short-term trading. It often takes a significant
run-up in price just to meet the spread - which basically
means breaking even on the stock. A significant price movement
is required to generate a gain in some stocks. You would do
well to stick with stocks with relatively narrow spreads.
Trying to beat the spread in the short term can be risky for
stocks with hefty Bid-Ask differentials.
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Watch out for profit taking activity.
A multitude of traders and investors
- each with different objectives and price thresholds will
be competing for the profit opportunities that present themselves
during narrow windows of time throughout the trading day.
As a stock price begins to move up, selling pressure comes
into play. In the early stages of upward price movement, there
will often be a great deal of volatility as trader's jockey
for position. Some traders will accept a modest profit and
get out early. Others who are sitting on the sidelines may
sense that an opportunity is brewing and attempt to move in
and out of the stock quickly. One thing is certain, however.
If the price continues to go up, at some point, selling demand
will begin to overwhelm buying demand and the price will start
to fall. Once price begins to fall, those traders who are
banking on a gain will attempt to get out of the stock quickly
- creating further downward price pressure. At this point
it will be difficult to execute a trade at a favorable price.
Indeed, it is unlikely that the late buyers will get out in
time to avoid a loss. It is important to try to ascertain
where a stock is on this timeline in order to avoid buying
in at a peak and then selling at a loss.
Focus on active, volatile stocks.
In the world of day trading, timing
is everything. If you spend your time following thinly traded
issues you will experience significant frustration as you
wait for small and infrequent price movements. You are most
likely to encounter consistent profit opportunities when you
focus on actively traded stocks with higher volatility. Of
course, volatility brings an additional measure of risk, but
the odds of seeing robust price swings that allow for short-term
profits are greater when trading active, volatile stocks.
Be decisive.
It is critical that you learn the
art of making quick decisions and moving on. One of the keys
to successful day trading is the ability to stay liquid. This
means that you must move in and out of ownership positions
quickly. Tying your capital up for extended periods of time
trying to squeeze the last penny of profit from a transaction
is completely counter to the day trading concept. Liquidity
allows you to watch from the sidelines as potential opportunities
develop. Then, at the appropriate moment you step in and take
advantage of a short-term gain. If you guess wrong, it is
still important to get out quickly to minimize your losses.
This approach requires discipline, but it is one of the few
strategies that allow you to make modest profits repeatedly
throughout the day. With that said, there is nothing inherently
wrong with holding a position for a longer period of time
- if it fits into your personal strategy. In fact, the willingness
and financial ability to hold a position for a longer period
of time will often allow you to avoid losses that would have
been incurred by selling more quickly in order to stay liquid.
Remember, however, that holding stocks for longer periods
of time will tend to reduce your profits as well as your risks.
Determine your sales price in
advance.
At the time you purchase a stock
you should have a clear profit objective in mind. Setting
a sales price target in advance will allow you to avoid the
common tendency to hold a stock too long. This removes greed
from the picture and allows you to make rational decisions
at a time when emotions are running high. Once you see your
price you must take it. And remember that windows of opportunity
can close very quickly.
Take advantage of limit orders.
Limit orders allow you to submit
a purchase order for a stock at a desired price. If the stock
achieves that price, the order is executed, if not, it goes
unfilled. Don't be afraid to submit a limit order well below
the current market price. By putting in a low-ball limit order,
you can take a relatively risk-free chance at buying a good
stock at a low price. Limit orders also allow you to set the
upper limit on a price that you want to pay for a stock. Be
aware that the price you see on your screen is not always
the price you will pay for a stock. If prices are moving rapidly
you may submit an order which will get executed at a higher
price than you were hoping to pay. By submitting a limit order
you will determine in advance the upper limit on the price
you are willing to pay for a stock. This will eliminate the
possibility of purchasing at a price that is above your threshold.
You should exercise care in using a limit order in this way,
however. As a general rule, if you broadcast to the world
that you are willing to pay up to a certain price - you will
end up paying that price - which may be higher than true market
value of the stock at the time of the order submission.
Don't forget about commissions.
Commissions, like Bid-Ask price
spreads, serve to minimize gains and accentuate losses. Just
because the price of a stock goes up, does not mean that on
a net basis you will make money on a transaction. In fact,
it is very difficult to consistently make money in trading
for this very reason. It is not enough to bet that a stock
will go up in price. The stock must go up sufficiently to
cover your price spread as well as your commission on the
transaction before you recover your initial investment. If
you execute a large number of losing transactions in a single
day you will be surprised at the additional erosion in your
capital base that comes from commissions and fees. It pays
to factor in commissions when determining the selling price
that will actually generate a profit.
Don't ignore taxes.
It should go without saying that
the profits derived from day trading activities are taxable.
If you are affiliated with a reputable brokerage firm, you
will generally be provided with periodic transaction statements
that will summarize your profits and losses. It is advisable
to secure the services of a qualified CPA to ensure that you
are complying with all applicable tax reporting and payment
schedules.
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Other On-line Resources are Available for Day Traders?
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