I’ve Got the Secret to Successful Day Trading

There are many ways to approach the market, but the one style that probably receives the least respect is day trading. It is viewed as primarily the domain of unsophisticated, small investors who are more gamblers than investors. There is some truth to that as bigger investors can’t trade enough capital in extremely short time frames.

There are statistics that show that day trading has a very low success rate, but they include foreign exchange, futures, options, and markets other than just plain vanilla equities. It is the markets in which leverage is used to the greatest extent where success is the least likely. That is a very important issue to keep in mind as you consider day trading. If you use high amounts of leverage, your chance of failure is much higher.

Ironically, the vast majority of very short-term trading is performed by institutions that move the market around by trading huge baskets of stocks with holding periods of seconds or minutes. This “algorithmic,” or “program” trading has a high success rate, but it often involves just a fraction of a penny, and it is a totally different game than that which is played by individual traders.

There is a perception that because a market approach is difficult, then it should be avoided. The reality is that the reason an approach can be so profitable is that it is hard to do. You don’t get rich doing easy things. You get rich doing hard things very well. There are many folks who work hard at day trading, and they do extremely well with that approach.

So how do you become a successful day trader?

The first step is to determine a clear style. If you just jump in and start randomly trading stocks in very short time periods, it is highly likely that you will not do well. Good day trading is influenced by finding stocks with substantial levels of volatility. If you are going to trade in extremely short time frames, then you need stocks that are moving very big and very fast.

Typically the stocks that are the most volatile will have news such as earnings, a regulatory approval for example by the Food and Drug Administration, new contracts, or other major events. These events attract a large group of very aggressive traders who are trading against each other. To a large extent, day trading is mostly about trading the emotions and reactions of other traders. It is more of a video game than it is an investing activity, and many day traders actively apply game theory tactics.

There are some day traders who focus on big caps or indexes, but the majority of day traders are looking at small-cap stocks. Many of them are low quality stocks and low priced and are getting manipulated in various ways. But from a day trading standpoint, the only thing that really matters is that they are making sizable moves.

I regularly scan all the stocks in the market to find names that are moving more than 10% intraday. Much of the action occurs in the premarket, but this is a fairly simple way to develop a good list of potential day trading candidates.

It is important to always be looking for sudden moves, but once you identify your trading candidates, then it is primarily a matter of watching them very intensely while waiting to employ your trading tactics. You will need very short-term charts that will allow you to develop a feel for how a stock is moving.

Trading tactics will determine your success. There are many different ways to trade high volatility, such as buying pullbacks to support — or volume weighted average price, often called, “VWAP.” Many traders look to buy strength and higher highs.

A large part of this sort of trading is measuring the psychology and emotions of traders and how they are influenced by the news that is moving the stock. How willing will they be to chase? Is there potential for a short squeeze, Will meme traders go nuts?

The most important aspect of day trading is the exit strategy. That is what will make you or break you. Chip Munn is a highly successful day trader who works with me at Sharkinvesting.com. His methodology is to buy a set number of shares and then exit as soon as he has a move of a set size. He will sell too early quite often, but he will seldom take big losses. He has a modest daily goal, and typically when he hits it, he will stop trading. What makes him successful is that he is highly focused on just a few stocks and is looking to extract very reasonable gains. He doesn’t use leverage or take big risks. It is very methodical and has a very high success rate. Chip is a retired airline captain, and in that line of work, he learned that you must always err on the side of caution. You can’t afford to make any mistakes. At the first sign of a problem, you act quickly and decisively.

Where day traders go widely wrong is that they take on too much risk. They trade too big and then become greedy and try to push trades too far. They aren’t satisfied with smaller consistent daily gains. They want to hit a home run every day, and that is what kills them.

The downside of this sort of trading is that there is a limit to how much money you can put to work, and you won’t have the giant gains that are produced by riding momentum in a larger position over a longer time period. You can only watch a few trades at a time, and you have to exit when you have fairly small gains if you are going to do it consistently. This sort of trading requires intense focus, and it can distract you from many other opportunities.

The upside of day trading is that if you do it right, then you have very low levels of risk, and it may only require a few hours of active trading per day. There is no concern that something that will hit overnight and cause your account to drop during nontrading hours. You don’t need a lot of capital to engage in day trading, but a lack of capital often results in impatience and in taking on too much risk, so that needs to be recognized.

Traditional Wall Street sneers at day trading, and the majority of people that try it do not do well, but if you make an effort to learn it and develop a sound strategy, it can produce a consistent stream of profits.