All About DAY TRADING

THE EASY WAY TO GET STARTED

McGraw-Hill Education

Contents

CHAPTER 1

What the Day Trading Game Is All About

The day trading game is all about making money. On the surface it would seemthat there isn't much more to day trading than making money. To someindividuals, however, day trading is more about the challenge and the excitementthan it is about the money. Every day our lives present us with many challenges.There are numerous ways in which we can put ourselves in the position of beingchallenged. Day trading in my view is not something we should do for thechallenge. While it is true that a great deal of satisfaction can be gained frombeing a successful day trader, we must not enter into the day trading game forthe purpose of meeting a challenge but rather for the purpose of achievingfinancial victory.

Given the vast increase in volatility during the 1990s and 2000s, there are moreopportunities to profit from large and even small intraday changes now than everbefore. At the same time, commissions, computers, and communications costs arealso lower than ever before. That combination has created a win-win situation,but only for those who are able to master the game. This, of course, leads tothe inevitable question, how do we master the day trading game?

There are literally hundreds of ideas out there in the trading world about howto win as a day trader. A keyword Internet search on the term day trading yields44,800,000 results. That is truly a staggering number; were we to track downevery lead, it would leave us no time to actually day trade. And so the goodnews is that there's a great deal of information out there about day trading.The bad news is that there is so much information, it is impossible tocritically assess the accuracy and validity of all of it. Finally, we come tothe worst news: I estimate that over 98 percent of the methodologies offered orpurported to be successful are neither objective nor profitable.

Today, more than ever before, the aspiring day trader must be especiallycautious not to throw away good money on bad methods. Today, more than everbefore, the aspiring day trader must be vigilant in doing her homework andresearch in order to find day trading methods that will make money. While daytrading has been presented to—or rather sold to, or rather hyped to—the publicas a good thing to do, the fact of the matter is that for most traders, it is abad thing to do. This is not because day trading is inherently a losingproposition; it is because day trading is not only the most difficult type oftrading to execute but also the most difficult at which to succeed.

Day trading is all about taking advantage of large or even small predictableprice movements in stocks, Forex, and futures. The day trading game, when playedsuccessfully, is about achieving profits using objective, operationally defined,and demonstrably profitable tools. Combined with these tools, a risk managementapproach is critical for success. But without a profit-maximizing strategy, theday trading game will be all about frustration and losses as opposed to profitsand success. It is my intention to share with you in this book several toolsthat I have developed in order to win the day trading game.

I would like to emphasize the following critically important facts and factorsthat will facilitate your success as a day trader, whether you use my methods orother effective trading ones.

1. Begin your day trading venture with sufficient capital. By that I meancapital that will not only be purely speculative but also allow you to day tradethe markets that interest you with enough money to buffer or withstand a seriesof losses.

2. Day trade in time frames that are consistent with what you can realisticallydo. If you intend to sit at the computer all day trading stock index futuresusing five-minute data for your signals, then make sure you really can be backat the computer every five minutes, or even more frequently, to see if there arenew signals.

3. Don't trade too many markets at the same time. Most traders cannotrealistically day trade more than several stocks, currencies, or commodities atthe same time without either missing signals or making mistakes.

4. Use objective, rule-based entry techniques as opposed to interpretivetechniques. To put it another way, don't trade on intuition or "gut feel"because that will not be profitable in the long run, even though initially youmay achieve some success. Gut feel is not a trading method or system.Unfortunately, that is the approach most day traders use.

5. Employ strict, risk-based rules for managing your losses. Simply stated, donot assume more risk than your account can tolerate. I will give you somespecific time-tested rules for doing so.

6. Use a profit-maximizing strategy that will, if properly implemented, extractthe greatest possible profits from winning trades.

7. Be prepared financially and psychologically for a series of losing trades. Itis not unusual for day traders to suffer from five to seven consecutive losses.

8. If and when you do suffer a series of consecutive losses, do not take thenext profitable trade off your books quickly in order to compensate for thelosses. Let your trades run their course by the rules.

9. Use a specific trading model that will help you not only generate your daytrades but also determine what to do, when to do it, and how to do it. Having atrading model will also help you identify specific errors you may have made andwhen you made them.

10. Avoid excessive inputs to your trading strategy; having too much informationis just as bad, if not worse, than having too little.

11. It is often better to trade in isolation than it is to surround yourselfwith news, the opinions of other traders, and a plethora of superfluous inputfrom so-called experts.

In addition to the suggestions cited above, I will share with you in the pagesthat follow specific trading ideas, methods, and indicators that will give youthe edge in day trading.

Finally, no book on day trading, or any type of trading for that matter, wouldbe complete without a clear and concise statement about risk (yes, still anotherone). I'm certain that you have heard it all before, but I must repeat that daytrading involves risk no matter what you may have been told by others. Despitethe fact that when you day trade you have no overnight exposure to a loss, thereis still exposure during the day. If you believe day trading is easy or that youare virtually guaranteed a profit, you are sadly mistaken. Day trading is atbest demanding, time-consuming, and all too often frustrating. Day trading isnot an instant cure to financial woes. Day trading is not a game, although manytraders consider it to be one. Day trading is a business that, if done correctlyand with discipline, can be profitable, but it is by no means easy or a surething.

CHAPTER 2

Why Day Trade?

Success as a day trader: it's the American dream. It's the capitalist dream.It's the get-rich-quick dream. It's the entrepreneur's dream. It's thebe-your-own-boss-and-work-from-anywhere dream. It's a dream that almost everyone has hadat one time or another. But it's also a dream that very few get to pursue andvery few get to fulfill. All markets—stock, commodity, and Forex—definevolatility. In other words, they move back and forth, often rapidly, all day andall night long. The unstable economic backdrop in the United States and Europehas created an underlying sense of uncertainty that has, in turn, housed itselfin a cloak of anxious trading. In order to capitalize on record price movementsover small periods of time, professional traders have resorted to suchtechniques as flash trading, high-frequency trading, so-called dark pools, andalgorithmic trading. These highly technical, computerized trading machines buyand sell stocks at a high frequency in large amounts in order to capitalize onsmall moves that occur during the day. The holding time for these positions isoften a matter of seconds, as opposed to hours or days or weeks. It is estimatedthat some 60 percent of trading in stocks is now characterized by such ultra-short-term forays.

The average investor does not have the financial or technical resources toparticipate in this fastest of all games. The professional investor has beenforced to participate in order to turn a profit in a game that has become highlycompetitive and highly regulated by government agencies. While professionaltraders and money managers have moved ahead into high-frequency trading, the daytrading game, which was once their domain, has passed on to the averageinvestor. Advances in computer technology, sophisticated software programs fortechnical analysis, historically low commission costs, and lightning-fast orderexecution using electronic entry have all combined to make day trading moreaccessible than ever before. We must not, however, equate accessibility withsuccess. The mere fact that it is easier than ever to day trade does not ipsofacto mean that all day traders will be successful. In fact, the reality of daytrading can be quite grim. Most day traders are not successful. They have noidea what to do. Most are floundering in a sea of misinformation anddisinformation within which it is difficult to obtain and implement strategiesthat facilitate consistent success.

Although many aspiring day traders see the stock, futures, and Forex markets astheir vehicles to financial independence, much of this expectation has beenshaped by ongoing promotional campaigns backed by exchanges and brokerage firms.As always, the task that awaits traders and investors is multifaceted:

1. In order to be successful as a day trader, it is critical to understand whatday trading is, what it is not, and what to expect from it.

2. Specific trading strategies must be developed in advance in order to identifyand isolate potentially profitable opportunities.

3. The markets in which a day trader will trade must be identified. It is notpossible to successfully participate in many different markets at one time.

4. A structured procedure must be developed in order to implement objective andorganized decisions.

5. Every aspiring and every practicing day trader must know in advance exactlyhow to determine the appropriate risk level for his account and financialcapability. Without knowing the risk for each trade, the end result will mostoften be loss.

6. Every day trader must define and refine precise procedures to ensure thattrades are not being made on the basis of emotion.

Simple as these challenges are to enumerate, they are exceedingly difficult toimplement because they require numerous decisions, sufficient starting capital,and highly structured procedures and rules. Without training and education, mosttraders will not be able to achieve their goals.

Given the multilayered challenges that await and confront all aspiring andpracticing day traders, one question naturally arises: why would someone want today trade? Before we can address the issue of why someone wants to day trade, weneed to understand the new definition of day trading. Why do I use the term newdefinition? Most markets now trade at least 20 hours a day continuously, whilesome are essentially 24-hour markets (e.g., Forex currency trading). Currencyfutures in Chicago are traded 23 hours a day. Stock index futures tradevirtually around the clock. So, before discussing the why of day trading, weneed to understand the what of day trading.

An insomniac can sit in front of her computer and literally trade 24 hours aday, six or even seven days a week. Realistically, this is not possible orpalatable for most of us. On the other hand, we can implement day trades duringthe day session, which is more manageable and does not require attention 24hours a day. In stocks the day session is clearly defined from the opening tothe closing time of the stock market. In the futures markets, many exchangeshave differentiated between the day session and the extended session.

For the purposes of this book, I will consider day trading to be entering andexiting trades during the course of the day session, as defined by the variousexchanges or the particular markets or stocks that are being traded.

Within the context of this definition, there are a number of reasons I cansuggest in support of day trading. Note, however, that all of these assume thatday trading is approached from an objective standpoint, with specific rules forentry and exit and, moreover, specific rules for limiting losses. Now that wehave defined day trading, we can look at some of the reasons for doing it.

REASONS TO DAY TRADE

While the primary reason to day trade is the obvious (mercenary) one—namely, tomake money—that goal is unattainable unless other factors are taken care offirst.

A viable reason for day trading that might not be obvious to most traders isthat the day trader must exit trades by the end of the day. In so doing the daytrader is forced not only to take profits but to take losses. Given that mosttraders blunder by carrying losses too long and exiting profits too quickly,being forced to exit by the end of the day is a great help to the trader whoadheres to the requirement that the day trade must be closed out by the end ofthe day session.

That most obvious reason for day trading is last on my list of importance, andthere are two aspects to it. The first part of this reason is, of course, tomake a profit. Without a doubt today's volatile markets are conducive to thisgoal. As an example, I offer Figure 2.1, the Japanese yen futures, showing whatcan occur on an intraday basis in today's markets. This is not the exception tothe rule. Consider also Figure 2.2, which shows the profit potential on anintraday basis in S&P 500 E-Mini futures. Observe that these potential profitsall occurred within the course of a day. Remember also that the profits shownassume that a day trader would have been on the correct side of the market.

The second aspect of this last reason is to maximize your return on capital.

In order to take advantage of these and many more day trading opportunities Iwill show you how to:

1. Familiarize yourself with how the day trading game is played by professionaltraders

2. Give you the rules by which you must live as a day trader

3. Show you five day trading methods

4. Tell you how to select your day trades

5. Explain how to manage risk and maximize profits

6. Give you a structured daily procedure to help you focus

ALERTING YOU TO A FEW POTENTIAL PROBLEMS BEFORE THEY HAPPEN

Given the broad scope of day trading, there are many opportunities that presentthemselves to the day trader. Within the course of the trading day we canimplement trades in many different time frames and in many different markets.The possibilities can be, and in many cases prove to be, overwhelming. Thenewcomer to day trading frequently makes the mistake of either trying to do toomuch or being afraid and doing too little. Some day traders want to day tradestocks, futures, Forex, and cross currency spread all at the same time. On theother hand, many new day traders are attracted to either the Forex markets orS&P futures. I've heard some new traders say, "My goal is to make $500 per daytrading E-Mini S&P futures. Once I have reached my goal, I'm done for the day."To me this means that the trader has arbitrarily decided to limit the profits hecan make, which places a top on his potential profits. If there is to be alimit, then the trader should impose that limit on the losing side rather thanon the winning one. There should be no limit to how much a trader wants to makeeach day.

Another problem I have seen is in quantity versus quality. The goal of many daytraders is to trade as often as possible for relatively small moves. The hope orintention here is to do what has in the past been termed scalping but whichrecently has been given a more politically correct term: high-frequency trading.The problem for the average trader is that, although she may make a profit 15 or20 times in a row for small money, one large loss will consume all of theprevious profitable trades, or even exceed them.

The professional high-frequency trader buys and sells positions in a matter ofseconds or even fractions of seconds, attempting to achieve large profits usinglarge positions on small price moves. This is a classic issue: would you rathersell a million widgets for a dollar each or five widgets for $200,000 each? Theaverage day trader cannot achieve success as a high-frequency trader and shouldnot attempt to do so.
(Continues...)Excerpted from All About DAY TRADING by Jake Bernstein. Copyright © 2013 Jake Bernstein. Excerpted by permission of McGraw-Hill Education.
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