What Do Day Traders Trade?
Day trading is a now a legitimate way to exercise analytical nous and make a decent living. Gone are the days when day trading was some sort of fringe activity practiced by a few brave souls. Today day trading is making heroes and celebrities out pf people. Books are now written on the subject and most of the mystique has been stripped away.
But getting into the day trading game is not so easy. A mature and sophisticated discipline now means beginners have volumes of information to wade through, most of which is not very good. Of particular significance are strategies; and the ideas that can take hold in the minds of a beginner and derail their efforts towards success.
I plan to use this piece to help you navigate these choppy waters of the beginner. I’ll discuss the strategies that really work, and suggest a couple of ways a beginner can parlay their grasp of these strategies to succeed trading everything from blue chip stocks to penny stocks.
There are three main strategies I will cover in this piece: 1) Liquidity Timing 2) Price Execution Planning 3) Capital Management
I am a firm believer in the notion that you can’t succeed as a day trader by following the herd. You might get lucky once in a while, but hope, like luck, is not a strategy. In order to avoid doing what the herd does you have to find ways to buck their tide of action. It’s a bit like zigging when they zag and nowhere can you manage this better than with liquidity.
Liquidity is all about demand and supply. A highly liquid trade, let’s say in a penny stock, will have a substantial amount of shares available for buyers and sellers to move around. The opposite of this true for illiquid stocks.
Most beginners take both extremes as signals to either buy or sell, but this is not necessarily the best strategy. What you want is a timing strategy that allows you to take advantage of imbalances in liquidity. For practical reasons and to make the best of liquidity imbalances, a beginner must pay close attention to the float. The float is the number of shares available to the public.
A small float puts upward pressure on prices if the stock is attractive in other ways; more people will want to buy it, and since there aren’t many shares to go around in the first place, prices rise.
Price Execution Strategy
This aspect of your overall strategy is very important. The common dilemma is this: “should I enter a trade at price x or at price y?”
The smart solution to this dilemma is to plan your trade in advanced. You do that by first setting your psychological threshold for profits and losses. Can you afford to lose say $500? Then your price execution strategy must take this fact into account. Many beginners mess up where this important detail is concerned. Too often they let their emotions run wild and what was an expected $2500 profit collapses to a $3000 loss. It can happen so I tell my students to set their mental thresholds early.
Planning also means you know your entry and exit points ahead of time. You manage both of these by stop-loss and limit orders.
Also keep in mind that you are sometimes not doing this in a static environment. If the trading day is already underway and the trade you are eyeing is in play, you might need to make this decision on price execution strategy very quickly. Practice, of course plays an important role; but the key I tell my students, is to have a clear picture in your mind of your limits (both from profits and losses).
This is where it gets ‘emotional’ for most beginners. One can understand why because it involves that most passion-stirring of things: money. The heady passions of money should not blind you, however.
Capital management is all about managing the money you have set aside for day trading – whether penny stocks or blue chip stocks on the NYSE or NASDAQ.
When I mention the term “set aside” to my students I usually get an evasive glance. Many start out by committing money they can’t afford to lose and so when I talk to them about they naturally get sheepish.
This is very important though; committing money you can ill-afford to lose is not just risky, it’s dumb. Many beginners never leave the beginner stage because of this oft fatal error in capital management.
The key therefore is to start small. With as little as $100 you can enter a trade and test both your liquidity timing and price execution strategy without fear of being wiped out in a trade. The best penny stocks are excellent for this sort of test-the-waters strategy and I always recommend it.
Of course these very good ‘how’ strategies, but I would be remiss if I failed to touch a little on the actual substance of your trades. This is ‘what’ of day trading that I find many of my beginner students fail to grasp coming in.
The question for many is whether they should trade blue chip stocks, penny stocks, or a mix of both. I say all three with one caveat: the beginner is best served throwing her energies into penny stocks.
I recommend penny stocks at the outset because they tend to have high volatility and this often helps to satisfy the liquidity timing strategy I outlined at the beginning.
The inherent high volatility of penny stocks also means potentially bigger profits over a shorter time span. You won’t see big moves and huge margins on stocks like Google because the growth potential in those kinds of stocks is largely priced in. With blue chip stocks you are really looking for long term earnings growth dividends. There are blue chip stocks that sometimes fall within striking distance of penny stocks (any stock trading under $5 is considered a penny stock). These you will find popping up on the NASDAQ occasionally; when they do they are worth a punt.