For those who have the time to follow the market for most of the trading day, day trading is a lucrative and exciting way to make money. Numerous different day trading methods can be applied, and they can be applied on numerous different markets. There is room for everyone to develop their own trading techniques using creativity, research and hard work. You can spend a lifetime learning new day trading tricks and various methods of day trading stocks.
If you want to become a day trader, you have to start somewhere. This is an introduction to day trading basics and a few basic trading strategies to get you started on your journey.
- What is day trading?
- What markets can be used for day trading?
- Day trading vs. swing trading and investing
- Is day trading profitable?
- What do you need to become a day trader?
- Overview of some of the most popular day trading strategies
- How to choose which day trading strategy to use
What is day trading?
Day traders attempt to profit from intraday price movements in any market. In most cases day traders will close all their positions on the same day they open. However, within that limitation, there is a lot of variety in the way day traders try to make money. Some day traders will look to enter a trade early in the day and hold the position until the end of the day while other traders will close a trade when it reaches a reasonable profit objective. Some traders will enter as many as 15 to 20 trades in a day, taking small profits as soon as they have them.
What markets can be used for day trading?
Day traders have a limited amount of time for a trade to generate a profit. Therefore, any market being considered by a day trader needs to move far enough on the average day to make a profit. Trading costs, in the form of commissions and bid offer spreads, also eat into profits. Slippage on entries and exits needs to be considered as well.
Day trading strategies need to have realistic profit targets that will generate enough profit to cover trading costs, slippage and losing trades and still leave enough to make a profit. Generally speaking, trading volume needs to be high and volatility needs to be reasonable for day trading to be profitable. Any market being considered for day trading needs to be liquid and have wide enough intraday ranges.
Profitable day trading strategies therefore require markets with good volume, tight bid offer spreads and at least moderate levels of volatility. You can trade stocks, indices, index futures, ETFs, forex and commodities intraday, provided the market is moving and the spread is narrow enough. The large equity indices, the major currencies, oil, gold and silver all qualify. Before considering other markets, you need to make sure they are liquid enough.
Day trading the stock market differs from other markets in that day trading only works for stocks that are “in play”. This refers to stocks that are in the news due to earnings releases or other events. These stocks usually are seeing increased volatility and trading volume. Therefore, these stocks offer ideal conditions for day trading.
Day trading vs. swing trading and investing
Strictly speaking, day traders close all their positions before the end of the trading day. However, if it looks like a large trend may develop, they may hold a position for overnight. Day traders will use 1-minute, 5-minute, 15-minute and hourly charts to execute their trades. Though, they will often use longer charts to provide context.
Swing traders focus on catching the moves that take from a day or two to a week or so to unfold. These moves usually occur with a trading range or channel. Swing traders use hourly charts to execute their trades, and 4-hourly, daily and weekly charts to provide context. Many intraday stock trading techniques can be combined with swing trading techniques to catch larger price movements when market conditions are right.
Day traders and swing traders are both concerned with price action and supply and demand rather than fundamentals. Both approaches are very different from long term investing. Long term investors look at the value of an investment based on the price level and the business fundamentals rather than short term supply and demand. Investments last for at least 6 months, but typically 2 to 10 years.
Is day trading profitable?
Thousands of traders around the world make a very good living day trading equities, indices, forex and other asset classes. However, it does take a lot of work to become consistently profitable as a trader. Intraday trades have smaller profit potential than trades that last days, weeks or months. That means there is less room for error. To be consistently profitable, day traders need to be selective with the markets and the setups they trade. They especially need to cut losing trades quickly. One losing trade can quickly ruin a trader’s P&L for an entire week.
What do you need to become a day trader?
Day traders need professional trading equipment and software. Trading on lower time frames requires a thorough understanding of the market you are trading. The margins for day traders are narrow and there is simply no room for error. To become a successful day trader, you need to get to know the intricacies of the markets you trade very well. You especially need to develop trading strategies that work for your personality and for the markets you trade.
Finding day trading strategies that work requires time, research and commitment. A day trading strategy that works for one person may not work for the next person. It will usually take some time to devise a set of day trading strategies that work for you. In the beginning of your day trading career, you need to invest in education.
An overview of some of the most popular day trading strategies
The best day trading techniques are those that traders figure out for themselves. However, it’s worth knowing a few of the popular day trading tactics that other traders use when you get started. The following are some of the best day trading strategies for beginners to consider:
Intraday trend following
Trendlines and moving averages can be used to identify short term trends. Positions then can be entered in the direction of those trends. Unlike long term trend following, day traders need to wait to enter positions at favourable levels. Trend following is an easy day trading strategy. However, it should only be used if prices are moving decisively and the market is not stuck in a trading range on a higher time frame.
Intraday trends do not occur every day, and you must make sure the right conditions exist to trade potential trends. High volume and a breakout from a narrow range are good precursors to substantial intraday trends. The above chart is a daily S&P 500 SPY ETF candlestick chart. A red candle that is much larger than the average candle is a sign of sudden fear or uncertainty. This creates the ideal conditions for intraday trend following.
The chart above shows the intraday price action that occurred after the large red candle on the daily chart. Whether the market continues lower or reverses, strong trends will usually occur.
By looking at medium term trends, trading ranges and support and resistance level, profitable trading opportunities can be identified. Reversal trading works well when there is low probability of a trend or breakout continuing. When a market begins to consolidate it will often continue to trade in range for a few days. These are the ideal conditions for mean reversion trading. You should continue with this strategy until prices break out of the range.
The chart above shows the intraday price action that occurred during the consolidation period shown on the previous daily chart. Clearly mean reversion strategies worked here, while trend following did not.
Chart patterns and market structure
More experienced traders look at the overall market structure, including technical chart patterns on longer term charts, to identify potential price moves that may occur. One of the best chart setups for day trading is a very narrow trading range which lasts several days, followed by an intraday breakout. After prices break out from a trading range, you can use trend following strategies or momentum strategies to catch the move that follows. If the breakout fails, and prices move back into the initial range, you can revert to mean reversion strategies.
Most momentum strategies that can be used on longer timeframes, can also be used for intraday strategies. Momentum trading is especially effective when multiple time frames are used. For example, if prices reach a support or resistance level on a 4-hour or 1-hour chart, you can then use a 5-minute chart to trade a potential reversal.
When trading momentum set-ups, it is important to use a stop loss order to exit the trade as soon as possible if the expected move fails to occur. You can also use a trailing stop loss to protect profits in case of a reversal. Intraday momentum strategies work well for stock trading when volume and volatility are increasing for a particular stock. Other advanced day trading strategies include market profile and Fibonacci trading.
Other useful day trading tips and strategies
The following are two very effective approaches to use for intraday trading, while using longer term price action for context. They are especially useful for day trading stocks.
Trading the second reaction to news
A stock will often move suddenly after a new announcement. Amateur traders will often jump into a trade to avoid missing a big move. However, sometimes the big move doesn’t materialise, and sometimes the volatility means those amateur traders will be shaken out before they have a chance to make a profit. Professional traders will wait for the market to pause or retrace, and then they will look for the next move.
The above chart is for Canopy Growth Corp, a cannabis stock. On August 15th, Constellation Brands announced they were taking a large stake in the company. The stock initially rallied to $32, but quickly fell back to $29.20. Anyone trading on a very short time frame would have been stopped out of a long position. The more reliable approach is to wait for the first reaction, and then trade in the direction of the next move. Very often a move that starts with a news announcement will reverse completely, creating profitable short trades.
Trading with three timeframes
Using charts on three different timeframes can be a very effective way to find profitable opportunities for intraday trades in the direction of the long-term timeframe. The time frames should each be 3 to 10 times larger than the lower timeframe. Day traders will often use a weekly, daily and hourly chart, or a daily, hourly and 15-minute chart.
The longest timeframe is used to define the trend. You want a clearly defined trend on that longer timeframe, and you will only trade in the direction of that trend. The middle timeframe is used to identify a substantial move against the trend on the longer timeframe. You can use an RSI or stochastic indicator to identify an overbought or oversold level. Finally, the shortest timeframe is used to spot a strong move in the direction of the trend. A strong move will indicate that the price is lily to begin moving in line with the long-term trend again.
How to choose which day trading strategy to use
The best day trading strategy for you to use depends on three things – your own personality, the market you are trading and the current market environment. Successful day trading strategies depend as much on the trader as they do on the actual strategy. You also need to be completely comfortable with the day trading strategies you use, and they need to make sense for you. We also highly recommend our article on trading psychology.
It’s a good idea to develop a process that you can use to decide if a trend following strategy is more likely to work on any given day, or if a mean reversion strategy is more likely to be profitable. In a trending environment you will then use a trend following strategy, and in a mean reversion environment you’ll use a counter trend strategy.
Conclusion: Day trading strategies for beginners
Now that you know a few of the popular day trading tips and strategies, you can begin to develop your own tool box of day trading techniques. There are plenty of resources on the web to learn day trading strategies and begin developing your own. Day trading online can be very rewarding provided you are committed and prepared to put in the time. Successful day traders take their trading seriously and treat it like a full-time business rather than a hobby.
It’s worth the effort though. Once you can consistently generate profits in one market, you will quickly be able to transfer those skills to another market. You will be able to work without having to answer to a boss or deal with clients, and you will be able to trade wherever and whenever you like. Are you an active day trader? What’s your preferred day trading strategy? Please let us know your thoughts in the comments below.