We can reduce the amount of time and "homework" it takes to find highly tradable securities by running screens and stock scans but there is still the common problem of making strategies far more complex than they need to be. Complex strategies generally start from a simple strategy which works well for the trader, but then that strategy is tweaked and re-tweaked in an attempt to make it even more profitable.
If this tinkering has worked with some strategies, that's excellent, but it is common for the trader to begin to have too much on their mind; profits cease and the trader ends up going back to simple strategies anyway or fading from the market. There seems to be an allure to complex and bizarre strategies. While a method may sound elegant and sophisticated, that in itself will not put money in the trader's pocket. (For more, see Getting To Know Stock Screeners.)
Is Simple Better?
Complex strategies can easily draw in traders since it is somewhat logical that the more information we factor into a system, the more reliable it will be. Yet, the market does not always reward logic and when it does it, it may not do it in the trader's timeframe. Remember, the market can be wrong a lot longer than the trader can afford to be right.
In the end, price is all that matters to traders, and yet price is morphed into all sorts of derivatives and indicators to supposedly give traders an edge. While these derivatives and indicators do often have validity, if we want to get back to simplicity we need to focus on price. In this light we will look at a day trading strategy which only looks at price and current movements since price movement is what actually creates profits. As Einstein said, "Elegance is for tailors," and as it relates to trading, elegance and complexity do not necessarily mean cash in hand.
While there are examples of failed complex (and simple) strategies, probably no example is more prominent than the demise of long-term capital management (LTCM). While this was not a day trading firm, it does show that complex strategies do not guarantee success. There is always a risk of loss (even when trying to get rid of risk like LTCM did) no matter what strategy is traded. Thus it is arguable that price is what should be traded, and the strategies used should be simple, easy to implement and able to control losses. (To learn more, check out Massive Hedge Fund Failures.)
Capture the Daily Range
This strategy involves looking at price tendencies in a given stock and trading within that context. While there are no guarantees that a given tendency will continue, by trading with that tendency we are putting the probability of profit on our side.
For this strategy we will need to track the average daily range after the open price. In other words, we need to know the average intra-day range. We pay no attention to gaps, and gaps are not included in the average intra-day range. The average we use should be average over the last 20 trading days, and exclude any extremely volatile moves which may be due to company or economic news events. The average daily range is simple calculated as High-Low. To convert this to a percentage, we take (High-Low)/Open. Once we have data for 20 trading days, we add up the percentage moves each day, and divide it by the number of days to get the average.
This may sound like a bit of work, but it is actually a very simple process once the high and lows each day are tracked in a spreadsheet. Also, several trading platforms have an average range indicator which provides the average intra-day range over a set amount of time. Please note, this is not average true range (ATR). ATR factors in gaps, and is thus not useful for this trading method. (To learn more, see Measure Volatility With Average True Range.)
|Figure 1: Smithfield Foods Inc. Price History|
Figure 1 is a chart of SFD which was quite volatile at times in September and October, 2009. The chart shows September 2 and September 5 on a five-minute time frame. On October 2, 2009, the stock dropped off the open (horizontal line) and then traded higher and moved above the open. We would buy as the price passes through the open. Our target is the average range minus the move which has already occurred that day. If the stock moved on average 5%, and the stock has already moved 3.8% (in this case), our target is 1% above the open price (slightly less than average to increase our chance of hitting our target) in the direction we took the trade.
The trade on October 2, 2009 would have resulted in a 13 cent profit on this initial move through the open price. The price fell back through the open and could have provided an additional gain on a quick scalp.
October 5, 2009 provided a more profitable trade as the stock dropped at the open (horizontal line) and then quickly rallied for a large percentage gain. This trade would have resulted in an approximate 37 cent+ (3%+) gain as we capture most of the daily average range. (For more, see Day Trading Strategies For Beginners.)
Stops will depend on the volatility of the stock, but can often be kept quite small as the initial move back through open is generally quick and does not put the trader offside for long. The stop amount should be smaller than the expected profit.
This is one example, and it should be remembered that there are multiple stocks we can watch at any given time. Not all stocks will provide trades at the same time, thus we can make multiple trades in multiple stocks. We also must remember that not all trades will be profitable, but if we can capture a share of the daily range and keep losses small we stand a good chance of making an overall profit.
The Bottom Line
Simple strategies based on average price movements can put the probabilities in our favor for making profitable trades. No system is perfect, and losses will still occur with this strategy, but if we trade multiple stocks and keep stops tight relative to potential profit we stand a good chance of making money. Since a complex strategy cannot guarantee success any more than a simple one, when we can trade "simply" we should.
Our goal is to gain insight into the average intra-day range of the stock and then capture part of that move by buying or selling as the price moves back through the open after having moved in the opposite direction after the open. Our target is the average percentage move minus the move which has already occurred before our entry. (To learn more, see our Day Trading Tutorial.)
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