Day trading is a specific trading technique where a trader buys and/or sells a financial instrument multiple times over the course of a day to exploit minute volatility in the asset's pricing. It is more commonly an institutional phenomenon, as a financial institution can highly leverage its transactions to boost its profitability. As many brokerages allow for trading online, day trading can be conducted from virtually anywhere, with only a few necessary tools and resources, allowing private individuals to get in on the game, too. But day trading is inherently a high-risk investment strategy — one that requires a great deal of knowledge, expertise, time and patience.
So how do you know what stocks are best suited to this type of trading? Read on to find out more.
Consider Your Own Position
Just like everything else in your financial life, the stocks you choose for your day trading strategy should be tailored to your goals and your personal situation. After all, there isn't a one-size-fits-all approach. Consider how much capital you have, what type of investing you're going to take on and your tolerance for risk. And don't forget to discount research. The best way to do that is to study the market, read up on company financials, consider what sectors best reflect your personal needs, personality, and values, and remember to start early. You'll need to get a head start on the trading day, so it's a good idea to time yourself according to market openings.
A few things to keep in mind while you're day trading: Don't get emotionally attached to any particular stock. Remember, this is all about looking at patterns to figure out when you can best enter and exit to make a profit or minimize your losses. And keep up to date on the news. You don't need to be attached to your TV, but you should know when earnings season is and what the economic calendar looks like. This should help you find potentials for your trading day.
High Liquidity and Volatility in Day Trading
In financial markets, liquidity refers to how quickly an asset can be bought or sold in the market. It can also refer to how trading affects the security's price.
Liquid stocks are more easily day-traded and tend to be more discounted than other stocks, making them cheaper. In addition, equity offered by corporations with higher market capitalizations are often more liquid than corporations with lower market caps. That's because it's easier to find buyers and sellers for the stock in question.
Stocks that exhibit more volatility lend themselves to day-trading strategies as well. So a stock may be volatile if its issuing corporation experiences more variance in its cash flows. While markets will anticipate these changes for the most part, when extenuating circumstances transpire, day traders can capitalize on asset mispricing. Uncertainty in the marketplace creates an ideal day trading situation.
Check out some of the online financial services such as Yahoo Finance or Google Finance. These sites will regularly list highly liquid and highly volatile stocks during the day. You can also get this information from most online broker sites in real-time.
Trading Volume and Trade Volume Index (TVI)
Day traders frequently use the trade volume index (TVI) to determine whether or not to buy into a stock. This index measures the amount of money flowing in and out of an asset.
The volume of the stock traded is a measure of how many times it is bought and sold in a given time period — commonly within a single trading day. More volume indicates higher interest in a stock — both positive or negative. Often, an increase in the volume of a stock is indicative of price movement about to transpire.
Financial services corporations provide excellent day-trading stocks. Bank of America, for example, is one of the most highly traded stocks per shares traded per trading session. BoA is a prime candidate for day trading, despite the banking system being viewed with increased skepticism, as the industry has demonstrated systemic speculative activity.
Bank of America's trading volume is high, making it a relatively liquid stock. For the same reasons, Wells Fargo, JP Morgan & Chase, Citigroup, and Morgan Stanley make for very popular day-trading stocks. All exhibit high trading volumes and uncertain industrial conditions.
The social media industry has also been an attractive target for day trading. The massive influx of online media companies — think LinkedIn and Facebook — has been followed by a high trading volume for their stocks. Moreover, debate rages over the capability of these companies to transform their extensive user bases into a sustainable revenue stream. While stock prices theoretically represent the discounted cash flows of their issuing corporations, recent valuations also take into account the earnings potential of the companies. Thus, some analysts argue this has resulted in higher stock valuations than the fundamentals suggest. Either way, social media continues to be a popular day-trading stock group.
Beyond Your Geographical Boundary
With any portfolio, it's important to diversify. That means looking beyond your own backyard. Consider other stocks listed on other exchanges including the Hang Seng in Hong Kong or the London Stock Exchange (LSE). Going global will give you access to foreign stocks and potentially cheaper alternatives.
The Bottom Line
While it may be a risky investment strategy, day trading is also very common and can be highly lucrative — provided you know the basics. Variables such as the relative liquidity, volatility, trading volume, and variable industrial conditions are all contributing factors in determining what stocks are best for day trading. To become a day trader you'll first need to decide on a broker that fits your needs. To help, Investopedia has made a list of the best stock brokers for day trading.