DAYTRADING STRATEGIES

Market is not your friend. Much like war, in daytrading and/or short-term investing, you are pitting your wits against every other person in the market. Every dollar you make is on the back of someone else’s losses. Your goal is to win with your investments and your trading and that requires someone else to lose – try to make sure it’s not you. Never forget that and you’ll be off to a much better start in the markets.

How risky is daytrading? Well, before you read this page any further, imagine taking about $20,000 in crisp, brand new one hundred dollars bills out into the back yard. Put them on the ground and douse them in lighter fluid. Then strike a match. Don’t burn your money just yet, but just stand there. That’s about how risky.

Always remember: at any given time, when you are daytrading for a living, you are risking probably that much money (if not quite a bit more) and your money is in perhaps just as much risk. And while we are not suggesting that you actually set fire to your money in the backyard, our analogy is fairly accurate. If that bothers you, then perhaps you might consider another line of work, or a good mutual fund, because we don’t know any good day traders that haven’t seen at least $20,000 go up in a puff of smoke during market hours. It’s simply unrealistic to expect to be able to trade professionally and profitably from day one. Mistakes will be made; lessons will be learned; money will be lost as you learn. It’s a never ending process to a large degree. In fact, the day you feel you have mastered the markets, that’s the day you get your head handed to you.

In the years we have traded, we have seen many people come and go. we’ve seen people make and lose large sums of money very quickly. We have made and lost large sums of money very quickly! We’ve seen stocks go from pennies to hundreds of dollars and back again, taking traders and investors for a ride both directions. And yet, still, in all the years we have been in this business, we are sure of only one thing about the market: that we have not seen it all yet.

If anyone claims to have all the answers about the market, or claims to be the only person you should listen to – run, don’t walk away from them and/or their services. While we don’t claim to know everything, our site and staff does have a tremendous amount of combined experience when it comes to trading and investing. Our goal is to help educate and provide cost effective software that you can use along side your own trading. Are we perfect? No. Certainly, not perfect. But we do feel tradingsimulatorsoftware.com and our staff can do an excellent job of helping traders learn the markets while mitigating risk as much as possible.

So, before going any further, put away the match and let us try to help you with your daytrading education. In the following text we will try to impart some of the knowledge we have acquired while day trading for a living. While these are not always hard and fast rules that can be applied to every situation, we do feel that they are helpful and represent a good starting point. In addition, we strongly suggest you closely review our book list for additional reading material.

HOW MUCH CAPITAL DO YOU NEED? – This is a very common question and one we receive quite often. By the same token, it’s also somewhat difficult to answer. How much do you really need in order to start day trading. How big a “stake” (a term used to refer to your starting capital) is required to get going?

The only answer is that it’s different for each person and it’s something you must consider for yourself before you start. However, we feel that, generally speaking, you should have enough trading capital to purchase between 500 to 1000 shares/2-4 contracts of any given instrument. Ideally, without having to use margin.

So, if you are in the habit of trading $40 to $80 stocks, this could mean you need as much as $40,000 to start. At the same time, one can trade with as little as $10,000 and get their feet wet. It also doesn’t hurt to have enough capital to diversify into several different positions (two to five generally) at one time – each with say 300 to 500 shares/2-4 contracts. Just remember, if you are starting small, keep your expectations realistic. Certainly, someone trading with $10,000 to $20,000 is going to have a much more difficult time generating $1,000 per day than someone using $100,000 or more. As long as you keep this in perspective, it will help keep you grounded as you begin learning.

When you get into the bigger leagues of day trading, then it’s nice to be able to “step on” (i.e. purchase or short) a “block” or two of instrument. This would be generally defined as 10,000 shares/10-20 contracts. This typically is going to require $500,000 or more of trading capital, plus some use of margin in limited situations and for a limited time. When you reach this level, it’s easy to see how daytrading can become quite profitable (and quite risky!). A few points (or even a few fractions) across 10,000 shares/10-20 contracts can return quite a bit of money quite rapidly. Just remember it goes both ways; you can quickly lose quite a bit as well.

There’s no right or wrong answer with regard to how much you need to start. Simply keep your objectives in perspective and reasonable. This will go a long way to giving you a good start in the markets. Also understand that if you are starting small, factoring in things such as equipment fees and transaction costs may become much more important.

REDUCING RISK AND PROTECTING CAPITAL – Reducing risk to your money and protecting your trading capital must come before making money in the market; it must always be put first in your mind when trading. You must learn and become comfortable with this being your first priority when trading. we know that sounds a little strange, but it’s 100% true and a very important mind set to get into. After all, you can’t play the game if you don’t have the dollars. You should always be willing to give up a trade in order to reduce risk and save capital.

You absolutely must seek to reduce risk and protect yourself at every turn in the market, even before making a profit. Don’t get me wrong, you are here to make a profit, but never at the expense of taking silly risks.
Always consider the risk to reward ratio of any trade you plan to take up. What is the risk? What is the reward? Keep that ratio in your favor and you’ll be well on your way to making a good start in the trade and protecting your trading capital. we would rather miss 10 trades, than make 10 bad ones. Any trader would. Reduce risk, reduce risk! Bad trades, mistakes, and large risks are like leaks in a dam. Forget about everything until you correct the leaks, then worry about increasing the water level.

GET YOUR FINANCIAL HOUSE IN ORDER FIRST – Trading and speculation in markets (more commonly called ‘Daytrading’) has been around as long as the market has been in existence. Whether it’s the days of the Buttonwood tree on Wall Street, or the Bucket Shops of the 1920’s, or the electronic trading that takes place every day across the Internet, there are and there always will be “traders”.

It’s certainly not difficult to imagine that the first time a person bought a stock and saw it go up, they had the urge to sell and take a quick profit. Daytrading is nothing new – it’s simply human nature to want to take a quick profit and then repeat the process.

Some people would like you to believe daytrading is something new and that therefore it must somehow be “bad”. However, when you really stop and think about it, daytrading is really no more risky than any type of investing or financial speculation. Any investment or trade can go bad, just like any trade or investment can go well. Just talk to anyone that has owned large amounts of real estate for any extended period of time. There have been times in the economy when interest rates sky rocketed and suddenly exposure to a large mortgage has been quite risky. No matter what the situation, speculation with any financial instrument brings some amount of risk – especially if done incorrectly or unwisely. Daytrading is no different.

Certainly, daytrading, like anything else, can be risky if you don’t know what you are doing. we’ve known of people making one silly mistake and getting wiped out over night. Since daytrading does come with a certain amount of risks, it’s only wise to get your financial “house” in order before you begin. As such, a few basic guidelines are in order.
First, we should understand that there are two basic categories of people that tend to seek out daytrading and that these two categories are drastically different in their approaches to the markets.

The first (and more historically typical) category is made up of people who are basically financially well off. These include individuals who have solid financial worth from other means. They also tend to have homes which are paid for (or largely paid for) as well as being relatively high net worth individuals, particularly in the liquid assets category. For individuals in this category, daytrading most likely is only a small part of an overall (and diversified) investment strategies or portfolio – and typically it’s only used to further an already solid net worth without exposing a high percentage of the individuals assets to undo risks. Basically, these are individuals that can “afford” to do a little day trading and typically don’t go over board in “only” speculation.

The second (and not only more recent, but more dangerous) category tends to be people who are attempting to build their net worth strictly from daytrading. These are individuals who view daytrading not so much as simply one small aspect of an overall financial investment landscape, but more as the major way to generate and build their entire financial worth. This tends to also be the category of people who take larger risks and sometimes generate a bit of negative press regarding daytrading. This negative press would be along the lines of people that daytrade using funds from a credit card and/or home equity mortgage of some form or another. When things don’t go well in the markets, typically the losses tend to have a more dramatic impact on the individual’s net worth and life style.
It’s pretty clear that these are two radically different approaches to daytrading. If you are in the first category, then as long as you do not expose more than around 10% to 20% of your overall liquid net worth to speculation, you probably won’t get into too much trouble. However, if you fall into the second category – where you are trying to create wealth through daytrading and/or you are using daytrading as your only means of addressing markets – then some guidelines are in order. Of course, at the end of the day, no one can force you to follow these guidelines. However, if nothing else, you should strongly consider the following information as it relates to your individual case.
First and foremost, you should never trade using money you cannot honestly afford to lose should some catastrophic event wipe you out in the markets. These funds should be largely similar to funds you would ear mark for Vegas or other forms of higher risk speculation. In the event you lost these funds in total, they should not have any dramatic impact on your life whatsoever. Generally speaking, these funds should represent no more than 10% to 20% of your overall liquid net worth. Beyond this, you should strongly take into account areas of your financial picture such as home ownership, outstanding short and long term debts, as well as future responsibilities such as college for your kids, etc. You should also take into consideration your age as it relates to your future retirement. Daytrading at age 20 or 30 is one thing, daytrading your retirement funds at age 65 or 70 is a whole different situation and very unwise unless you limit the amount of funds at risk.

Again, before you undertake anything but causal daytrading, you should seriously consider such things as paying down all of your short term debt. This would include paying off all credit card balances and any loans which may be near maturity. You should also consider allocating funds for and/or paying off longer term debts such as car notes and/or home mortgages. Additionally, if you have a family to provide for, you should not only consult with your wife, husband, etc. before attempting any sort of daytrading, but you should take into account what impact large and unexpected losses could have on your current as well as future living situation.

Generally speaking, unless you have tremendous earning power, you should have very little debt and a stable housing situation before using much capital in the markets for day trading.

KNOW YOUR LIMITATIONS – What did Clint Eastwood say? “A man’s got to know his limitations” (of course, this goes for a woman as well). You’ve simply got to be realistic about what you are capable of. we hate to say it, but some people are just not cut out for trading. However, self evaluation can sometimes be very difficult. It kind of falls into the category of “nobody thinks they are a bad driver”. Obviously, if you didn’t think you were able to be successful at daytrading, then you probably wouldn’t be reading this page. However, just because you think you will be successful at trading, doesn’t make it so.

So for those of you that are unsure if you are cut out for it or have difficulty with self evaluations, here’s our sure fire way to determine if you are a good daytrader: look at your bank account.

If your account goes up, then you are doing well. If it goes down, you are not doing well. If in a couple of years you have more money than you started with (without adding more funds), then you are off to a good start. If you have less, then you are making mistakes. If in five or ten years you are consistently making money and/or have enter the big leagues of trading, then you probably are cut out for it. If in five or ten years you are broke or having to fund your trading from other profitable areas of your life, then you probably aren’t cut out for it. At the same time, you are only a failure if you quit. Our philosophy has always been never give up. If the person that became successful on the 20th attempt had stopped at the 15th attempt, then they would have been a failure.

Daytrading can be a very hard road; you don’t learn this stuff over night –
 it takes months, even years to become even a half way decent and savvy trader. No one walks into this business and learns it over night. It’s like anything else in life – it takes time, it takes practice and it take the ability to learn from your mistakes. If you find you tend to blame your mistakes on everyone else – forget it – stop while you still have some money and get a day job. we’ve never met a good trader that pointed a finger at someone else. At the end of the day, no body forces you to enter the trade. No matter what advice you follow, what service you use – the buck ultimately stops with you – as it’s your decision to follow through with the trade in the end. One thing you will never hear a successful trader say is “we lost money, but it wasn’t my fault”. Every good trader we know takes full responsibility for every trade they make and every action they take.

If you cannot say to yourself “we messed up that trade big time and we’ll never make that mistake again!” then you have selected the wrong business to be in. You simply have to be able to stand back, look over what you are doing and honestly evaluate what is working and what is not working. If something you are doing is not working, then you must make changes. Trading is a highly fluid type of business, it’s always changing and you must adapt and change with it. What you must do, ultimately, is learn what works for you – not what works for everyone else – what works for you. Part of that is knowing your limitations.

BE CONFIDENT IN YOUR TRADING – Taking up a position in an instrument when you are less than 100% confident is just a disaster waiting to happen. Being confident doesn’t mean being right. You can’t always be right. However, based on the facts you have available to you regarding the instrument and/or company, you can be 100% confident that you have done your homework based on what information you have available to you. Anything less than this will tend to induce uncertainty into your trading. This will often times undermine your confidence and ultimately your ability to stand firm when others are selling.

By the same token, you must also be confident enough to exit a position when you realize you have made a mistake in a trade. No one is suggesting you hold an instrument that is in trouble. Rather, you base your trading on facts, not fluctuations in the markets. Once you have made your decision to buy or sell, if you are right, ultimately the markets will come to you with a profit. Others may sell because they see someone next to them sell, but that is not, and never has been, the road to success on Wall Street. Don’t follow the crowd – follow your brain, follow facts. Be confident in your trading and thinking and you will generally (if you are smart and use all the facts at hand) come out on top a large percentage of the time.

HAVE A COMPLETE PLAN BEFORE ENTERING ANY TRADE – This is so critical to successful trading, yet so rarely do we see people do it. Before you ever place a trade, you must – absolutely must – have a plan of action for how you are going to handle the trade. What price you are going to pay, what price you are going to sell at, how many shares/contracts you will buy, what price you will cut your losses at, etc. This is critical. You must have a strategy to handle not only the upside, but also the down side. The good and the bad of the trade. Where will you sell the instrument should it move up and what price will you exit the trade should it move south. How long will you hold the instrument if it doesn’t move at all? These are all questions that should be asked and answered before you purchase any instrument for a trade. This goes hand in hand with being 100% confident. You must have a plan of attack.
Think of each instrument you buy like a battle to be fought on the battle field. You are the 4 star General of the trade. Do you think a General would direct his troops onto the battle field without a full plan of attack? Without thinking out every possible scenario or what could go right or wrong? This is exactly how you must approach each trade you make.

Just as important: once you develop a plan, adhere to it. If the instrument hits your sell price, sell and move on; if the instrument hits your stop, get out. Don’t change your strategies because of your emotions – change only because of additional facts which you did not have when you formulated your plan, or if you clearly identify an error. Never change your plan to try to justify your actions or justify the movement of the instrument.
Remember the old saying: the market is always right. To be successful, you need to understand the only mistakes that are made in trading are your own. As soon as you identify a mistake, take action to correct it, not justify it.

DIVERSIFY, DIVERSIFY, DIVERSIFY – Diversification, even in trading, is very important for risk reduction. Since you aren’t going to be correct in every trade you make, diversification is necessary and important as a means to risk reduction and capital preservation.

The simple fact is this: if you put all your trading capital in one or a very limited number of instruments, you are just asking for trouble and increasing the risk you are exposing your money to. At some point, if you trade long enough, you will undergo owning a stock that drops like a rock for one reason or another. Most people who have traded for any length of time have been there and it’s no fun at all.

Avoiding putting all of your eggs in one basket is the first step in limiting risk when it comes to both investing and trading.

AVOID INVESTING TOO MUCH IN A POSITION – There is an old story on Wall Street where one trader asks another trader for advice. He says, “we’ve bought so much of this instrument that we can’t get any sleep at night… what should we do?” His friend says, “Reduce your position down to the sleeping point. This is not only very good advice, but very true. The smart trader takes up no position in such large quantities that it makes him overly nervous or subjects him to loss of sleep.

Trade at levels which you can afford and you will generally feel much more comfortable in your trading. This will generally result in much clearer thinking and smarter decisions on your part. Too much risk will result in too much fear and that will cloud your thinking and judgment.

TRADE INSTRUMENTS YOU KNOW – 
Part of being confident about a position you take up relates to having some understanding of the company behind the stock. Clearly it is impossible to know every little detail about the day to day operation of every business you buy stock in. However, it does help if you have a basic understanding of the type of business they are in and how news (positive or negative) may relate to and/or impact a company and their stock. This will not only help you feel more comfortable about the position you take up, but it will allow you to more quickly evaluate news which may be released regarding the company.

Trade instruments you know or that are in areas you may have experience in. Warren Buffett is a good example of this philosophy. He has no problem telling share holders in his investment companies that he doesn’t understand much about technology related companies and therefore steers clear of buying such stocks. Sticking to what you know is not only a good way to start out investing and trading instruments, but it can help you feel more confident and make better decisions along the way.

TRADE POPULAR/LIQUID INSTRUMENTS – Instruments that are “popular” with the public and investment community have a very real benefit to your trading – specifically, they tend to be very liquid. Liquidity is a measure of how much volume changes hands on a specific instrument (typically on a daily basis). The more liquid the instrument is (i.e. the more shares/contracts it trades) the more likely you’ll get a fair price when buying or selling the instrument. Also, the more likely it is that there will be a market to buy from or sell into.

Trading instruments which have very low volume can incur additional costs and can limit your ability to get in and out quickly when so desired. Often times if you try to buy or sell a large block of instrument, there simply won’t be a market at current prices. This can result in the market “stepping away” from you when you go to sell. Worse yet, you can drive the price up on yourself. While there are times when buying a little known stock may work out, for most of your trading, you should strongly consider sticking to actively traded instruments. This is true of options trading as well (i.e. stick to options on instruments which trade higher volume).

TRADE STOCKS THAT ARE MAKING MONEY – The market is based largely on economics and business (with some emotion and perception thrown in). As a result, we feel it’s a good idea to trade stocks on companies which are currently showing a profit, as opposed to companies which “might show a profit someday”. Great ideas are a dime a dozen, as they say, and you don’t have to look far on Wall Street to find stock in companies that are using other peoples’ money to test out their “great” idea. In our opinion, we would much rather be trading stocks in companies that are currently profitable.

Additionally, keep in mind that even companies that are “making money” on the top line may not be “profitable” from a net (bottom line) profit standpoint. There are many companies out there that have racked up a tremendous amount of debt and/or have business models that, while they bring in quite a bit of cash, are unable to actually show a profit at the end of the year. Generally speaking, stocks which are currently showing a profit or are very close and very likely to show a profit in the near term, trade better and are somewhat less risky than stocks which are either in the red or struggling to show profits on their financial statements. Part of this is because valuations are much easier to calculate from real earnings (i.e. using the company’s P/E ratio) than trying to base valuations on “what might happen” down the road. True, sometimes stocks trade more actively or more wildly on news of potential profits, but at the same time, when a company announces they may not meet analysts’ expectations or may experience an earnings short fall, it can get quite dangerous. Consider sticking to companies with tangible, consistent earnings when doing your trading as a further means to risk reduction.

AVOID BUYING THE “BIG EVENT” – This idea tends to go hand in hand with the ideas presented above (regarding trading companies that actually are able to show a profit). In the market, there is always “some big event” that might take place for a company or the market. Buying or selling based on the possibility that this event may take place (or may not take place) or based on the how the market might react to such an event tends to turn your trading into a gamble more than anything else – and this is very risky.

Buying an instrument ahead of what might be a “big event” can be quite risky and often times tends to delay your trading. Very often these big events (such as mergers, buyouts, etc.) get delayed for months and months. If you wish to hold an instrument for weeks and weeks or months and months waiting for some big news flash, then that’s perfectly okay. However, just keep in mind that generally stocks move up on news far before the average individual hears about even the rumor of the news. As a result, you often see stocks trade down on positive news (due to the fact that the news was already anticipated long in advance and largely priced into the stock prior to the release of the actual news). Generally speaking, buying the big event will tend to be not only risky, but also will tend to slow down and stagnate your trading. Avoid when possible.

STOCK PRICES – Stock prices fall into two basic categories. Penny stocks (a.k.a. stocks trading under $1.00) and pretty much everything else. To some degree, you can lump stocks under $5.00 into the penny stock category as well, however, keep in mind that this will not always be a fair representation.

Lower priced stocks have a very seductive allure. Not only can you buy large numbers of shares/contracts, but when the stock does move, it typically moves in larger percentage steps. However, that works both ways and there are additional risks with lower prices stocks (typically they are lower volume and this can negatively impact your trading).
We feel much more comfortable trading an stock that is above $20 if at all possible. Generally, stocks which carry low share prices tend to be more risky. They also tend to be lower priced due to lack of interest from both the public as well as professional investment community. This is not to suggest that there are not good quality low priced stocks – certainly there are. However, especially when you are first beginning, we feel it’s best to avoid stocks which trade under $5.00 unless you really know what you are doing. In the end, you usually stand about the same chance of seeing a higher priced stock move 10% as you would seeing a lower priced stock move 10%. Since this is usually (but not always) the case, there tends to be a little more safety in trading in the higher dollar stocks. Penny stocks can and do sometimes produce amazing short term gains, but unless you really understand the risks associated with these lower priced and often more thinly traded securities, we suggest you stick to more “name brand” stocks which tend to trade at higher per share prices.

DON’T CHASE STOCKS – Stocks go up because people (usually large numbers of people) are buying the stock. As a trader, this is usually not a good time to also be buying. As such, be very cautious about buying stocks that are rapidly moving away from you. The true money in stocks is made by buying stocks prior to a sudden move, not during a sudden move. The one possible exception to this may be if there is some very positive news that has caught the markets off guard and/or if the news is so outstanding that there is a high probability that the stock may benefit for multiple days. Keeping in mind, however, that a sudden move in an stock is often quite different than a change in the overall trend. Sudden moves tend to reverse and if you get into the habit of chasing stocks that are moving up, more times than not you’ll end up paying overly high prices and/or getting caught in a downward move shortly thereafter.
Again, generally people that buy late are buying on pure emotion (greed and fear). Greed that they may make a lot of money very quickly and fear that they may miss out should they not “get on board”. Those are the two worst reasons to buy anything – not just stocks. True you may miss out on the stock, however, in most all cases, it’s better to wait and find another stock, than to pay too much. Patience in the market is very important; usually you’ll do better by avoiding the temptation to “jump” when that impulse is largely a result of a move in the share price alone.

DON’T RUSH INTO ANY TRADE – This is along the lines of the above comment, however it is worth elaborating on. Often times instruments will give you many chances to get into them at current (or sometimes even lower) levels. Generally, there are few cases that require sudden action if you are really careful in how you trade. Sometimes the best trades are ones in which you wait patiently for the instrument to come to you. If you feel the need to rush to order an instrument , that’s sometimes (not always, but sometimes) a warning sign that you are acting not on a well laid out plan for the trade, but an impulse to “get into a trade” regardless of whether or not the instrument is trading at what is really an ideal price.

Keep in mind as well, it’s often not a bad idea to take up positions in a trade little by little. If you plan to own 1000 shares/2-4 contracts, consider buying 300 shares/1 contract and then seeing how the instrument trades. Often times this will allow you to better judge the market and take advantage of intraday weakness. If you do happen to miss purchasing the additional shares/contracts, there is almost always another trade you can put the cash to work in.

DON’T GET GREEDY – Two of the biggest emotions a trader has to over come are fear and greed. Many traders fall victim to greed once they see a trade become profitable – simply by not having a firm exit point in mind. It’s generally best to decide at what levels you wish to sell prior to entering into a trade to avoid this. If you feel yourself trying to justify higher levels from the instrument and/or ignoring the current profit “as though it were nothing” you probably need to stop and consider not only the value of your profit, but the current risk to it by holding longer.

Often times traders who are successful tend to lose respect for the actual value of a dollar. Regardless of how much money you have, you must not lose sight of what each trade produces and the value of the returns in relation to the capital used to produce those gains. An example might be someone with several million dollars. If this person put $10,000 into a position and saw it produce a gain of $2,000 they might not realize it’s time to take profits. While $2,000 is nothing when compared to several million, a 20% gain should always sound alarm (i.e. sell) bells in a trader’s head. In fact, typically a gain of 10% or perhaps even as little as 5% should do this as well. A common method to help combat this is to look at your trades strictly from a percentage standpoint of view, rather than a dollar standpoint. This allows you to always calculate gains and losses with consideration to the amount of capital at risk for any given trade.

In the movies, “greed is good”, but in trading it’s generally an emotion that does little more than get in the way of clear and level headed thinking.

CONTRARIAN THINKING –
 Generally, a trader should meet buying with selling and vice versa when it comes to the market. Typically, instruments (especially when considered on an intra-day basis) will only go so high, or so low, before tending to attract the next group of contrarian thinkers and switch direction. Often times crowds (such as the markets) are wrong in their actions and over react to the up or down side. When the “markets” as a whole are moving up dramatically or down dramatically, there is a strong case to be made that these actions ultimately will be wrong or will tend to reverse simply as the contrary views of things builds on each side of the fence.

If you can train yourself to go against your natural emotions, you’ll tend to be able to keep a clearer outlook on the markets. When instruments are being bought, you have to train yourself to think “These instruments are buying bid up too high – maybe we should sit back and wait”. By the same token, when there is a great deal of panic selling in the market, you need to train yourself to think “Wow, look at all these prices falling – we may find good deals here soon”. It’s more difficult than you think to be “happy” when the markets are falling and “cautious” when the markets are raising. However, normally taking this view of things will help improve your trading over the long haul. The old saying, “Buy when there is blood in the streets” stems from this basic idea of going against the masses on Wall Street.

TRYING FOR TOPS AND BOTTOMS – People tend to have a desire to buy at the bottom and sell at the top. Not just near the top, but the “exact” top. It’s simply human nature to want to be the best at something and trading is no different. Most people that take up daytrading want to be the best they can be. However, aiming for exact tops and bottoms when buying instruments can be very detrimental to your overall trading.

we would much rather give away 10% at the top and 10% at the bottom. You will drive yourself crazy if you punish yourself for not selling at the high or buying at the low, as it’s almost impossible for most people to do on any sort of consistent basis. Far more often than not, you’ll simply end up missing the trade. Even missing a top or bottom by 20% is nothing to worry about. As many a successful trader has said, “you can worry about the tops and bottoms and we’ll worry about the remaining 60%”. In fact, it’s often much safer to wait until an instrument clearly signals a move either up or down before taking up your position.

STOPS – Some people use stop orders quite often, some people hardly use them at all. In our view, stops are best used to protect a nice profit and/or limit down side risk in a trade that isn’t acting as you think it should. How a stop is used (or placed) is largely dependant on the individual instrument and how the overall market is behaving at any given time as well.
Often times using stops also helps to remove some of the emotions from trading. It’s far easier to place a stop on a trade than watch it trade tick-by-tick and try to decide the exact moment to get out.

TAKING PROFITS ON BIG GAINS – At some point, just like experiencing a large loss, you are likely to hit a really big winner. When this happens, consider taking 1/2 your gains off the table right away to reduce risk to the profit you have just made. This allows you to continue to profit, but protects a large amount of the money you have just made. Additionally, you may wish to consider selling enough of the position to recoup your original investment. This results in the remaining shares/contracts effectively being “free” and allows you to hold them indefinitely without any fear of a “loss” to your original capital (which has now been removed completely).

SHORTING – When shorting instruments, there are several points to always keep in mind. Never short an instrument simply based on the instrument price. To really be successful as a short player (i.e. someone that shorts instruments), you need to locate instruments which are extended with a significant void of fundamental reasons. There must be some reason for the instrument to decline in the near term (e.g. declining profits, lack of direction, etc.). Simply shorting an instrument “because it has a high price” is just inviting danger.

Additionally, keep in mind that shorting instruments exposes you to additional risks which are not present when buying or going “long” an instrument. These include having the instrument called away from you, as well as being caught in a short squeeze. Also keep in mind that the very act of shorting an instrument increases the pent up demand for the instrument – namely the number of people that will ultimately have to repurchase the instrument down the road to cover.

Finally, a good rule of thumb is to never short an instrument which may end up on the front page of the Wall Street Journal or some other major financial publication. Typically, the best short candidates are instruments which have moved up rapidly on little or not fundamental changes and which are generally not well know to the investment public at large. While it’s true you can make money shorting well known, large cap stocks, it tends to expose you to additional risks not associated with smaller and less well known companies.

PLACING ORDERS – Buying/Selling instruments appears fairly straight forward at first glance, however there are several points you should consider before blinding placing your first trade to buy or sell an instrument . Following is a brief outline of points to consider:

First and foremost, you need to understand that instruments are sold to you at one price and bought back at a slightly lower price. This difference is called “the spread”. And while the spread has generally decreased over the years, you are still taking a hit when you purchase an instrument (assuming you should want to turn around and sell right away). The bid price is the price the market will pay for an instrument when you go to sell it, while the ask price is the price quoted to those who wish to purchase the instrument from the market. Nothing says you cannot try to buy at the bid and sell at the ask, but this will generally delay your execution.

On the topic of bid and ask prices, you should note that there is a corresponding “size” which relates to how deep the orders run on the bid and/or ask size at any given price. As an example, you may have 100 people trying to buy an instrument at a specific price, while only 10 are trying to sell. This directly impacts how much instrument is available at any given bid or ask price. Once the orders to buy or sell an instrument at a given price are filled and/or cancelled, the price adjusts according to the remaining orders – either at higher or lower prices. If there is a ‘void’ of orders at any given level in the market, an instrument is said to “free fall” or “gap” to where ever there are buyers or sellers. Keep in mind as well, how this area of pricing is handled is sometimes dependent on where your instrument trades.
Next, you should understand there are several different types of orders that can be placed to buy or sell an instrument. The most common is called a “market order”. This means buy or sell at the market price. However, keep in mind once this type of order is placed; you are nearly powerless in your control of the price paid should the market make a sudden move. In a very active market, you can also run into situations where your confirmation (showing the price you paid for the instrument) is delayed significantly. This makes it extremely difficult to judge what a “fair and accurate” price is and/or when your order should have been executed. It also opens you up to possible foul play when it comes to how your order is processed and/or handled. As such, unless you are dealing with a fairly orderly market, we suggest using what are called limit order.

A limit order works just like you might think. It is an order with a limit price attached to its execution. When you place your order, you specify a limit to the price you’ll pay. While limit orders are usually executed after market orders, they do provide a higher level of protection against over paying, etc. Additionally, we feel they are a fine method to use when trying to take up a position at a lower than the market price. You should keep in mind, however, there are two types of limit orders. A stop limit as well as a market limit. A stop limit order is an order which becomes a stop (such as a stop loss) once the price is reached. Keep in mind with this sort of order, the market can pass right by you, where as with a normal limit order (which basically turns into a market order once hit) you stand a better chance for not only execution, but seeing an improvement on your execution price (this is because once your market order is set, the market may move in your favor during execution, but you will never pay more than your limit).
Limit, stop and market orders apply directly to both buying and selling of instruments.

STAYING ON THE SIDELINES – Sometimes being in cash gives you the best strategic position from which to trade – and this is often an overlooked fact of daytrading. Remember, you can’t take advantage of market dips if you are already in the market! In our view, it’s better to be out of the market more for day trading than in the market. This will allow you to get in and out with profits quickly and be on the sidelines should dips occur. It also drastically reduces the risk to your capital as compared to just sitting in instruments that aren’t moving and/or holding trades for excessively long periods of time. Try to be out of the market more with your trades and in the market more with your investments (as long as they are good investments of course).

MOST IMPORTANTLY – One of the most important and most widely over looked aspects of being a successful day trader is working on your personal life and how you conduct yourself. Most of the personality traits required to be a successful trader are also the traits found in someone that is said to have Character.

Rarely have we met a successful trader that we didn’t like. we’ve found – almost without fault – that people who are successful at the market are also fairly successful at “life”. These are people that show integrity in their lives, as well as consideration and honesty. They are people that deal with others in a generally polite and honest manner. As mentioned above, rarely have we run into a successful trader that will “point a finger” or blame others for their mistakes. Integrity, honor, character, fairness – these are all qualities that not only make up general character in a person, but also are the foundation of a successful trader.

If you aren’t naturally “humble” that the market will do an excellent job of teaching you how to be. Always keep in mind that the market is nothing more than dealings between human beings – it’s just people doing business. And how this business is done is a reflection of all involved, as well as you yourself.

To be successful in the market, you must start by getting your house in order when it comes to yourself and how you deal with other people. If you are a dishonest person, or you blame others for your own mistakes or have a lack of integrity in your character, chances are high than this will come back to haunt you in the end – not only in life, but in the market.

Discipline, fairness and honesty – those are all traits we have found in successful people and above and beyond all else, successful traders.