Day Trading can be a dangerous game for anyone who doesn't adhere to a well-thought-out strategy.
As I’m sure you all know by now (and if you don't) Day trading is the act of buying and selling some sort of financial vehicle within the same day. Your transaction as a day trader, is opened and closed within the same session. Positions can be initiated multiple times over the course of a day, but are most certainly always closed just before the session ends. The crux of day trading is very simple, its all about taking advantage of small price moves..which can be a very lucrative game to play—if it is played correctly!!! That’s the only caveat…it must be done correctly. That is what this week's blog is all about. I personally play the game from the perspective of what I stand to lose if I’m wrong and what could happen if I don't manage risk correctly.
So, let me be blunt: Day Trading can be a dangerous game for anyone
who doesn't adhere to a well-thought-out strategy.
As day traders we’re always looking for two main attributes to trade. Liquidity and Volatility. The two go hand in hand when it comes to trading. You NEED both to successfully make it as a day trader. Just for clarification, in simplest terms, “liquidity” is the level of ease you’re afforded to get both in and out of a stock. A high level of liquidity means that the market or stock you’re trading has a lot of participation involved and trading in and out of a position is simple. Low liquidity is the opposite. Locating buyers and sellers is not exactly easy. A market with low liquidity, can in some cases, be seen through how wide the spreads are. Those spreads add to your risk and transactional costs…
Day trading stocks with low levels of liquidity is NOT a good idea!
On the other side of things, Volatility is another MUST HAVE when trading. It is simply a measure of “possible/expected price movement in price” over a specified period of time. Day Traders need to be trading volatility. It’s like I've always said…”volatility is the air that traders breathe”.
There are too many stocks out there to trade daily and not all of them (or even a small portion of them) are going to provide us with opportunities to day trade. A ton of time can be wasted reaching for stocks that are volatile. Newer traders get lost in the mix looking for tradeable opportunities. It’s for that reason (saving time) that we use scanners. I personally scan and look for very specific attributes on stocks…
Things that I focus on when looking for a tradeable opportunity is
A low Float of under 100mil shares. The reason I like smaller floats is that the float itself will give you insight into the demand of the stock. For example if a stock has 100mil shares to trade, and the average volume is just 1mil, but on the day your scanner found it trading 80-90mil shares at the open there is a demand story. Now the question is: what's the news? What is pushing traders to trade this?
Another must is a Strong Daily Charts (above the Moving Averages and with no nearby resistance). I personally follow a simple rule of being net long is price is above the 200sma and net short when price action is below the 200sma. Some traders really like to see the MA’s stacked and hold price long (reversed for a short). Stacked MA’s offer more support and strengthen the idea of a long trade. Reversed is said for the short side of the market!
High Relative Volume of at least 2x above average is also another important aspect. Remember, the higher the volume, the greater the participation levels are. More people trading, more liquidity. Higher volume will generally be the by-product of A fundamental catalyst such as a PR, Earnings, FDA Announcement, Activist Investors or some other kind of breaking news. Stocks can also experience momentum without a fundamental catalyst. When this happens, it’s called a technical breakout.
One of the better strategies for traders to engage is the Opening Gap strategy. A gap, simply put, is a situation where price is set to open at a higher level from where the previous close was. Gaps are typically based on catalysts like mentioned above. If price action was to gap higher and hold, it suggests that there is a lot of demand for the stock…for one reason or another. The great thing about gaps is they (most of the time) will either rip even higher (Gap’n’Go) or will immediately fade (Gap’n’Crap). Both are perfect tradeable situations that I take advantage of!
There are 4 keys that you must follow when day trading…understanding and following the rules below will help you achieve and maintain a higher level of consistency!
#1) choosing the asset you’re going to trade-Stocks, Options, Crypto etc. You must know what you’re trading!
#2)Entry points-Once you have located a high probability opportunity where are you getting in? What is the Low Risk/High Reward entry point?
#3) Profit Targets-Before you’re in, you have to know where you’re getting out!
#4) placing a stop loss-The best trading strategies fail. With that we have to trade from a position of playing hyper defense…know your risk threshold. What is the MAX you’re willing to lose before you bail on the trade? You have to know that off the top!
More on Risk Management….
Again, a successful strategy will NOT win all the time. No trader or trader based program wins 100% of the time. Many Wall Street traders only win 50% to 60% of the time. With that said, they make more on their winners than they lose on their losers. That’s why it’s important to understand you reward to risk profile. 3x the reward to risk is pretty solid! Even at a 50% success ratio you’re going to make money consistently! Make sure your risk on each trade is limited to a specific percentage or dollar amount of your account… and that entry and exit methods are clearly defined and written down. These are all things that need to be written down and mapped out in your trading plan!
Successful traders have to move fast, but they don't have to think fast. Why? Because they've developed a trading strategy in advance, along with the discipline to stick to that strategy. It is important to follow your formula closely rather than try to chase profits. Don't let your emotions get the best of you… don’t abandon or strategy jump when you’re going through a rough patch. There's a mantra among day traders: "Plan your trade and trade your plan."