An Introduction - Day Trading

By Frank Miller


Day trading is the practice of active buying and selling of the stocks, options, futures and currencies within a trading day. All trades are completed within a day so that after the closing of market the day trader do no hold any open positions and therefore are not subjected to any overnight risks. The traders trade against very small changes in price of the financial instruments. Day trading is usually a vigorous trading activity requiring high concentration and time during trading hours.

The first is that the day trader is less exposed to event risk than a long term trader. I get in and out of the market as quickly as possible. I am in the market during primary trading sessions, so my stops are normally filled at or near the specified price. A long term trader may find that an unforeseen event triggers big moves when primary markets are shut, forcing price to gap way beyond protective stops when markets re-open. Minimizing exposure to event risk while trading leveraged instruments is a key benefit of day trading, and why I think it is one of the least risky forms of trading when done properly. Another reason I prefer day trading is that I can work through losing spells more quickly. All trading methods encounter drawdowns when traders have a losing spell. If a typical drawdown for your system spans a period of 10 trades, and the average duration of each trade is 2 weeks, you face drawdown periods averaging twenty weeks. But if you are a day trader completing one trade each day, your average drawdown period is just 10 trading days. If you complete more than one trade per day, the drawdown period is even shorter. It is never pleasant being in drawdown and it is easier to stick to your system if drawdowns are short. Twenty weeks, or more, in a loss situation tests the resolve of any trader.

Day trading can be considered as an offspring of high speed electronic communication networks. Most day traders today trades markets from a distant location such as their home or work area. They use trading software, the direct access trading platform, installed in their computer connected to internet to execute trades in real-time. In order to qualify for the trades, the trader must maintain a margin in the corresponding market. It is the day trading broker who maintains the margin for the trader and provides the direct access trading platforms. Although there are web-based trading platforms available, they are not suitable for day trading.

Day traders work in short time frames, so trade profits are smaller. Where it might be reasonable for a position trader to target 100 points of profit over a period of several weeks, the day trader may realistically be limited to targets of 5 - 10 points. If trading costs for each trade are fixed at, say, 2 points, you can see that they constitute just 2% of the long term target profit, but may be 20% - 40% of the short term target profit. Unless a market has sufficient volatility for a trader to target profits significantly larger than trading costs, it is not suitable for day trading. Fortunately many such markets exist. Soybean and wheat futures are good examples. Suitable markets often have another advantage. Their periods of volatility frequently occur at specific times, typically short periods near the open and close of trading sessions. For example, I can usually enter my daily trade during the first thirty minutes of the trading session.

An early entry is especially good if the exit strategy can be automated. I can set up an OCO (one cancels other) group to implement my exit strategy without having to monitor the market after the trade is entered. Thus, after watching the market for up to 30 minutes to find an appropriate trade entry, I can set up the OCO group and just leave the trade to work. As I live in Australia and trade at night, this means I can go back to bed! Finding the right entry is the great challenge, especially in the fast moving period as a market opens. The trader hasn't got a lot of information to go on at this stage. I've generally found technical indicators to be worse than useless at this time, because they react to price changes too slowly. Most professional traders try to determine support and resistance levels, based on significant turning points in prior sessions, or the extremes of an opening range established in the current session. Traders then apply one of two broad strategies - either they sell resistance and buy support, or they buy breaks through resistance and sell breaks through support. They can devise an almost limitless range of tactics to implement either strategy.

Whichever approach is chosen, it is important to manage trades in such a way that the average winning trade (including trading costs) is bigger than the average losing trade (including costs). I aim for a ratio of 2:1, that is, the average win is twice the size of the average loss. I also try to keep my winning percentage of trades greater than 50%. Finally, I want a strategy to provide a trade on at least 80% of trading days. It is not much use having a great strategy which only provides a trading opportunity once in a blue moon! If your trading plan (a) gives you a trade on 80% of trading days, (b) wins at least 50% of trades, and (c) has an average win twice as large as the average loss, you are in good shape, providing the plan uses a sensible money management scheme. (It is vital to limit the risk in each trade so that a run of losing trades does not take you out of the game.) However, you still have to implement the plan, and that can be harder than it sounds. Simple errors made in the heat of action can have quite an impact on your results. And lapses in trading discipline, where you deliberately stray from your plan, can undermine the efforts of even experienced traders. It is especially tempting to deviate from plan when you have had a few losing trades. I find the best mindset is to look upon my trading as a daily trip to the casino, where I have been granted the right to place just one bet with odds in my favour. Over time, I ought to win, providing I have enough capital to survive short term runs of bad luck. But a casino has many temptations, and I could easily be lured into placing unplanned bets, or changing my standard bet to one that looks better, but has worse odds. Strong self discipline in the adrenaline pumped atmosphere of the gaming rooms is essential.




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