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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:


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.

What Other On-line Resources are Available for Day Traders?

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