Thanks to meme stocks like GameStop and AMC, retail day trading is back in style in ways not seen since the Dot Com boom. But while day trading may seem like an enticing path to quick riches, the real thing is a grind. Day traders must be vigilant for new opportunities at all times, which means spending a lot of time in front of a screen watching prices and analyzing charts.
Day trading is a tough game for beginners too. Most new day traders will lose money, so prepare to take your lumps if you’re just starting out. Using a demo account with paper money is a good way to practice without risking any real cash, but it’s not a perfect substitute for the real thing. Losing actual money is an emotional experience and you’ll need to keep your emotions in check to perform well as a day trader.
Want to get started as a day trader? First, you’ll need to understand the risks. Most traders will lose money – if trading was easy, everyone would do it, right? New traders tend to buy at peaks and sell at market bottoms, providing profits to the seasoned traders who follow a systematic, ruled-based approach. If you want to compete with these types of pros, you’ll need to develop a system of your own.
Why Pick a Day Trading Strategy?
For aspiring day traders, selecting the proper strategy is the most important initial step. What strategy works best? Unfortunately, there’s no blanket statement that can answer that question. Do you like public speaking? Odds say no. But I’d bet someone reading this has no issue with public speaking, which gives them an edge over the rest of us who can’t stand it. Use this mindset when developing your trading routine and choosing strategies. What abilities, skills, or personality traits can you use to give yourself an edge?
Some traders will be able to stomach huge volatility more than others, which gives them an edge when markets are gyrating like Beyonce’s backup dancers. Others will be more emotionless and satisfied with singles and doubles, never breaking their routine in pursuit of a home run. Find your edge and build your system – bouncing around from strategy to strategy is a quick way to lose money.
Here are a few of the most popular day trading strategies. Use a paper trading account to figure out which works best for you before jumping into real markets. Practice is important.
You can probably take an educated guess on how momentum strategies work. Momentum traders look for stocks on their way up and sell them as soon as they start losing steam. Momentum trading is often an ideal day trading technique since positions are very short-term and closed at the first sign of trouble.
Momentum traders are usually looking to score big wins and search for stocks with the following characteristics:
- Volume – High volume usually precedes a big move, so momentum traders want stocks with shares changing hands more rapidly than usual.
- Low Float – The float is the number of shares available for trading. When the float is low, high volume can send the stock soaring because it takes relatively few shares to entice a big move.
- Liquidity – One of the biggest drawbacks to trading low float stocks is the lack of liquidity in the market. Keep an eye on the spreads of the shares you want to trade. If the gap between bid and ask is high, you might have trouble getting your order filled.
The trick to momentum trading is getting out of the trade as close to the top as possible. You’ll need to balance the fear of sticking around too long with the regret of exiting the position too soon. Set profit and loss parameters and don’t look back once you close out the position. And don’t look back! If you scored a huge return on a trade and met your profit goals, it should be irrelevant to you if the stock bounced up or down another 20% from there.
When a stock makes a large move on low volume, it often leaves a blank space on the chart between two candles. This empty area is called a gap and usually is formed due to some type of catalyst rocketing the value of the shares higher or lower.
Gap trading is similar to momentum trading, but the presence of a catalyst is a key component of gap trading. If a company announces a new government contract or successful results from a drug trial in the evening, the stock may gap up the next morning and continue to rise once the opening bell rings.
However, gaps can be deceiving as well. When a gap up or down occurs without a catalyst present, be cautious in your approach to the stock, especially if the volume isn’t unusual. You’ll often hear traders refer to a ‘gap fill’ – this happens when a stock retraces back through the empty space on the chart to the original level. Anticipating a gap fill is another way to play this strategy since there are no support or resistance levels in the gap space.
If you’ve been to a professional sporting event, you’ve surely seen ticket scalpers. These guys buy unwanted tickets and sell them to fans who can’t get tickets at the window. They only make a few dollars off each ticket, but they often scalp hundreds of tickets in a single day. Lots of small wins can add up quickly and that’s the thought process behind scalp trading.
Scalp trading involves a series of highly sensitive trades when positions are entered and exited quickly. Whereas momentum and gap traders are looking for big winners, scalp traders want tiny victories that add up into large windfalls.
Scalp traders must have precise entry and exit points since every penny counts when utilizing this technique. You’ll need highly liquid stocks too since you’ll need to take a large position to benefit from the tiny price movement. Scalp trading is tough – it only takes one unexpected gap to ruin a day’s work.
Breakout trading involves identifying stock price patterns that signal a potential break in support or resistance. To breakout trade successfully, you’ll need to familiarize yourself with technical analysis, especially concepts like support and resistance.
Breakout traders look for specific patterns that could foreshadow an upcoming breakout. Some of the most popular patterns used in this type of trading are flags, pennants, and triangles. When a stock keeps bumping into a resistance level but finds support at higher and higher levels, it could signal a breakout is coming. Breakout traders will buy the shares before the stock bursts through the resistance level and then sell after the wave of incoming volume sends the stock higher.
Breakout trading can also be done on the short side, as stocks break through support levels and tumble downward. While the signals are often effective, many false breakouts will occur as well. You’re bound to get frustrated at some point when a stock breaks out immediately after you give up on it, so always remember to stick to your system and don’t chase when utilizing breakout trading.
Trading the news is often a way to get burned in the stock market, but day traders who are nimble enough to jump in and out of positions quickly can still profit. Usually the motto for traders is ‘buy the rumor, sell the news’. But quick and attentive traders can act on news releases before the rest of the public.
To trade news, you’ll need more than a newspaper or TV set on CNBC. Today, news breaks on the internet, whether through social media, network sites, or independent outlets. One of the best ways to trade news is through a well-curated Twitter feed where real-time news breaks can be acted upon. If you’re waiting for a story to drop at the Wall Street Journal or New York Times, it’s probably going to be too late.
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Day trading is an exciting way to participate in the markets, but beginners need to be well aware of the risks. You’re going to lose money at some point – even the best traders and investors don’t have perfect records. How do you respond to a big loss? Can you bite your tongue and coldly move on to the next trade?
Your mindset is just as important as your strategy when attempting to day trade. Retail traders have a tendency to buy just as the peaks near and sell right as stocks bottom. After all, there’s a good reason why John Bogle recommended index funds to everyone. But if you want to try your luck in the day trading game, be sure to select a strategy that matches your temperament and test it out with paper cash before risking any real money.
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