Day Trading Basics and Strategy
Posted by Blain Reinkensmeyer
July 24, 2007 at 1:17 am
When it comes to investing online in the stock market, there are many different types of ways you can go about your business. Day Trading is one of those trading types that falls under the active trader category, and requires prior experience and skills to be successful.
What is Day Trading
Day trading is simply the act of buying and selling a security within the same trading day. So, if I wanted to daytrade Google, I would have to buy my shares than turn around and sell them before the market closed that day. Most people think a day trader is someone who just trades a lot, and while that is true, the dynamics of day trading are not for the faint of heart.
Day trading is difficult for several reasons:
- Commissions eat away at profits
- Discipline is a requirement, and perfection is recommended
- Consistency is key
Though $0 commissions are now starting to come into every day trading, for the sake of this article we are going to assume we are spending atleast several dollars per transaction. As well, we will assume that the average new trader is working with less than $10,000. With this in place, trade commissions become a problem because we cannot buy a stock for $10.00 and sell it at $10.01 for a profit. Every buy and sell transaction costs $x dollars and forces us to increase our spreads (more on that later).
Moving away from spreads, the aspect of discipline is so important with day trading because the process is very repetitive and one big loss can wipe out several successful trades. If you are turning .05% on $5,000 every trade you make, you are making $25 per trade (before commissions). That’s all great and dandy, but what happens when your position is down 1%? Do you hold or sell, and realize too that just because you sell for a 1% loss doesn’t mean you lost only 1%, you have to factor in the trade commissions as well.
This brings the next challenge to the topic of consistency, because without it you will be eaten alive. There are multiple buyer and sellers competing for your same order to buy and sell, and as any trader knows even a 50% success rate is a huge feat in itself. You have to be extremely consistent with how you go about finding opportunities to day trade all the way to executing both the buy and sell of the day trade.
Day Trading Steps
The process of making a day trade can be summed up in a few steps:
- Find a stock to daytrade that intraday is setup for a high probability of success
- Figure out your spreads, or more simply figuring out what you need to buy and sell at to make money
- Take the position
- Sell the position as quickly and profitably as possible
- Rinse and repeat
Finding prospects. Before we can even enter the battlefield we need to know how to find a stock to daytrade. There are many ways to find prospects, and to be successful we will need a decent understanding of technical analysis and intraday charts. I’ve seen daytraders trade solely off of hourly charts, 1 minute charts, 5 minutes charts, and the like. Coupled with these intraday charts though are things such as price range, momentum, and volatility. Bottom line to complete step one we need to be watching our stocks with a close eye for any patterns we know that prove to have a high probability of success when played correctly.
Calculating Spreads. After finding a good prospect, we now must figure out what it will take for us to make money. We figure this out by calculating how many shares we can buy, how much we make each penny the stock moves, and after commissions of the buy and sell how much movement do we need to make money. For example if we have roughly $5,000 to trade with and the stock is at $10 a share, we can buy 500 shares total. With 500 shares, we will make $5 for every penny the stock moves up. If our commissions are for simplicity sake $10 per buy and sell, that means to turn a profit we will need to atleast buy at $10 and sell at $10.05 which would yield us $5 in net profit after commissions ($.05 x 500 shares - $20 in commissions = $5). So, if we wanted to make atleast $50 on the trade, we would need to buy 500 shares at $10 a piece, and then sell those shares at a price of atleast $10.14 per share.
Taking the position. After we figure out what we need to do to make our money, we now have to get our hands on xxx shares at xxx price. Furthermore, our timing as to be as accurate as possible to insure we get in and the stock hopefully immediately moves up to our target price. This really is an art and can only be developed with practice. Hint: Use limit orders.
Selling the position. So we obtain our shares and now the stock is moving upwards or downwards. How do we play both sides of the table? If we place a stop loss order to protect ourselves on the downside we can’t place a limit order to sell at our target price. On the flipside a sell limit order will not allow us insurance on the downside. Good practice and discipline are the keys to success when it comes to selling. Stick to your limits and price objects if you want to succeed long term.
Rinse and Repeat. All of these steps could literally take place in a matter of minutes, from finding a play, to calculating your spreads in your head, to buying and then ultimately selling the same position for a profit. This is what makes day trading what it is.
Concluding Notes
Day trading is a lot more complicated than meets the eye. It is a game for the well trained and well disciplined investor, and when done correctly is not only profitable, but a hell of a good time. If you like the rush of stepping on the gas peddle in your sports car, than wait till you experience the emotions of a day trade. On the flip side though, daytrading can really take an inexperienced trader for a ride and be a costly style of investing. If you don’t come in with your gameplan you might as well leave your bets on the table because the market will eat you up alive.
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It’s amazing how many people want to daytrade on “feel”. So one will find the candidate and hope to make $0.50 out of a trade. He will then watch a chart until he feels comfortable and put the trade on. It is usually a hit or miss coin toss probability scenario.
The way to be truly successful from what I have seen is to have a robust, tested, explicit formula that over the long-term makes money. However, most people aren’t able to hold on for the long-term becuase when they take their first week of losses they begin to tinker with the strategy and essentially foul it up.
There are a few out there that can do it well, but most daytrader careers are short lived and end in disappointment. Make no mistake, daytrading takes just as much time and effort as long term fundamental investing so if an investor is looking for a shortcut, daytrading really doesn’t fit that scenario.
Good post - i enjoyed it!
Day trading rule #1:
Be properly capitalized or you WILL FAIL.
$10,000 is chump change. Traders must aim for approx. $100,000 minimum before they can ever consider doing this full time. Even at that figure, you’ll be very lucky to take down $50k for living expenes after all commissions, slippage, wins, losses, etc…
Plus, you’ll want to grow that stake so the percentages start to work in your favor to actually make it work for a living.
No one should be day tradign a $10,000 account, that is just silly.
Great article!
I agree, $10,000 isn’t enough money to make it worth the ‘time’. The only part missing from the article was the opportunity cost of the extra time spent day trading instead of running a business or working. Day trading isn’t just investing, it’s also a job and so you need your investment to make profit (as any investment should) plus pay your living expenses.
I don’t know if you would be interested, but I think you at one time day traded (I think I read that in a profile somewhere) and I was wondering how you did and what real world lessons you’ve learned.
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Less than $10,000 won’t get you anywhere? Well maybe that is the case for most of the people trying to daytrade. However there are guys out there, like the danish guy Flemming Kozok. He started out with $4,000 and turned it into more than $500,000 in one year…Nothing is impossible guys
I forgot to give you guys a link. You can check out the story here: http://www.spekulant.dk/kozok/index_eng.php
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