When people use the term "day trading", they mean the act of buying and selling a stock within the same day. Day traders seek to make profits by leveraging large amounts of capital to take advantage of small price movements in highly liquid stocks or indexes. Here we look at some common day trading strategies that can be used by retail traders.

Tutorial: An Introduction To Technical Analysis

Entry Strategies
Certain stocks are ideal candidates for day trading. A typical day trader looks for two things in a stock: liquidity and volatility. Liquidity allows you to enter and exit a stock at a good price (i.e. tight spreads and low slippage). Volatility is simply a measure of the expected daily price range - the range in which a day trader operates. More volatility means greater profit or loss. (To learn more, see Day Trading: An Introduction or Forex Trading Walkthrough.)


Once you know what kinds of stocks you are looking for, you need to learn how to identify possible entry points. There are three tools you can use to do this:

  • Intraday Candlestick Charts - Candles provide a raw analysis of price action.
  • Level II Quotes/ECN - Level II and ECN provide a look at orders as they happen.
  • Real-Time News Service - News moves stocks. This tells you when news comes out.

We will look at the intraday candlestick charts and focus on the following three factors:

  • Candlestick Patterns - Engulfings and dojis
  • Technical Analysis - Trendlines and triangles
  • Volume - Increasing or decreasing volume

There are many candlestick setups that we can look for to find an entry point. If properly used, the doji reversal pattern (highlighted in yellow in Figure 1) is one of the most reliable ones.

AT_RetailStrategies_1r.gif
Figure 1: Looking at candlesticks - the highlighted doji signals a reversal.

Typically, we will look for a pattern like this with several confirmations:

  • First, we look for a volume spike, which will show us whether traders are supporting the price at this level. Note that this can be either on the doji candle, or on the candles immediately following it.
  • Second, we look for prior support at this price level. For example, the prior low of day (LOD) or high of day (HOD).
  • Finally, we look at the Level II situation, which will show us all the open orders and order sizes.

If we follow these three steps, we can determine whether the doji is likely to produce an actual turnaround, and we can take a position if the conditions are favorable. Typically, entry points are found using a combination of these three tools. (For more see the Charting Section of the Forex Walkthrough.)

Finding a Target
Identifying a price target will depend largely on your trading style. Here is a brief overview of some common day trading strategies:

Strategy Description
Scalping Scalping is one of the most popular strategies, which involves selling almost immediately after a trade becomes profitable. Here the price target is obviously just after profitability is attained.
Fading Fading involves shorting stocks after rapid moves upwards. This is based on the assumption that (1) they are overbought, (2) early buyers are ready to begin taking profits and (3) existing buyers may be scared out. Although risky, this strategy can be extremely rewarding. Here the price target is when buyers begin stepping in again.
Daily Pivots This strategy involves profiting from a stock\'s daily volatility. This is done by attempting to buy at the low of the day (LOD) and sell at the high of the day (HOD). Here the price target is simply at the next sign of a reversal, using the same patterns as above.
Momentum This strategy usually involves trading on news releases or finding strong trending moves supported by high volume. One type of momentum trader will buy on news releases and ride a trend until it exhibits signs of reversal. The other type will fade the price surge. Here the price target is when volume begins to decrease and bearish candles start appearing.

You can see that, although the entries in day trading strategies typically rely on the same tools used in normal trading, the exits are where the differences occur. In most cases, however, you will be looking to exit when there is decreased interest in the stock (indicated by the Level II/ECN and volume). (For further reading, see Introduction To Types Of Trading: Momentum Traders and Introduction To Types Of Trading: Scalpers.)

Determining a Stop-Loss
When you trade on margin, you are far more vulnerable to sharp price movements than regular traders. Therefore, using stop-losses is crucial when day trading. One strategy is to set two stop losses:

1. A physical stop-loss order placed at a certain price level that suits your risk tolerance. Essentially, this is the most you want to lose.
2. A mental stop-loss set at the point where your entry criteria are violated. This means that if the trade makes an unexpected turn, you'll immediately exit your position.

Retail day traders usually also have another rule: set a maximum loss per day that you can afford (both financially and mentally) to withstand. Whenever you hit this point, take the rest of the day off. Inexperienced traders often feel the need to make up losses before the day is over and end up taking unnecessary risks as a result. (To learn more, see The Stop-Loss Order - Make Sure You Use It.)

Evaluating and Tweaking Performance
Many people get into day trading expecting to make triple digit returns every year with minimal effort. In reality, many day traders lose money. However, by using a well-defined strategy that you are comfortable trading, you can improve your chances of beating the odds.

How do you evaluate performance? Most day traders evaluate performance not so much by a percentage of gain or loss, but rather by how closely they adhere to their individual strategies. In fact, it is far more important to follow your strategy closely than to try to chase profits. By keeping this mindset, you make it easier to identify where problems exist and how to solve them.

The Bottom Line
Day trading is a difficult skill to master. As a result, many of those who try it fail. But the techniques described above can help you create a profitable strategy and, with enough practice and consistent performance evaluation, you can greatly improve your chances of beating the odds.

Related Articles
  1. Chart Advisor

    3 Ways to Trade the Rising Volatility

    With volatility increasing in the markets, many are turning to these three volatility-capturing exchange-traded products.
  2. Trading Strategies

    Stock Trading for Free: Now a Reality

    Believe it or not, you can now trade stocks and ETFs for free. Here's a look at providers offering commission-free trading.
  3. Chart Advisor

    Big Double Top Patterns On the Verge of Breaking

    These stocks have created big double top chart patterns, and are on the verge of breaking the patterns to the downside--a bearish signal.
  4. Investing Basics

    A Primer On Investing In The Tech Industry

    The tech sector can provide fantastic returns for investors with a little know-how in the field.
  5. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  6. Technical Indicators

    Use Market Volume Data to Determine a Bottom

    Market bottoms often carve out classic volume patterns that let observant traders make fast and accurate calls.
  7. Mutual Funds & ETFs

    7 Best ETF Trading Strategies for Beginners

    Exchange-traded funds are ideal instruments for beginning traders and investors. Learn the seven best strategies for trading ETFs.
  8. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  9. Trading Strategies

    The Top Spread-Betting Strategies

    What are the most commonly followed spread-betting strategies (in countries where it's legal)?
  10. Trading Strategies

    Who Actually Trades or Invests In Penny Stocks?

    Although penny stocks are highly speculative, millions of people trade them daily. Here are 10 different types who do.
RELATED TERMS
  1. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  2. Indicator

    Indicators are statistics used to measure current conditions ...
  3. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  4. Forex Spread Betting

    A category of spread betting that involves taking a bet on the ...
  5. Bid Wanted

    An announcement by an investor who holds a security that he or ...
  6. Mass Index

    A form of technical analysis that looks at the range between ...
RELATED FAQS
  1. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  2. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  3. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  4. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  5. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  6. How do I place an order to buy or sell shares?

    It is easy to get started buying and selling stocks, especially with the advancements in online trading since the turn of ... Read Full Answer >>

You May Also Like

×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!