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Day Trading

Terminology

Designated Market Makers

They work on the trading floor of the NYSE and their role is to match the buy and sell orders received from stock brokers. Designated market makers used to be referred to as specialists.

ECN

An Electronic Communication Network (ECN) is a market place where you can buy and sell stock directly if you use a Direct Access Broker or Online Broker. Unlike a stock exchange such as NYSE, companies are not listed on ECNs.

Market Maker

Market Makers are participating firms registered with NASDAQ and they provide quotes. Nowadays NASDAQ mainly deals with the larger orders from institutions such as mutual funds rather than small orders that typically come from most investors.

Profit Factor

The Profit Factor is a common risk management method of determining the Risk to Reward ratio for a proposed trade. The profit factor is calculated by dividing the trades expected profit target by the trades stop loss level.

Day Trading - picture of the NASDAQ building for day traders to place their stock orders with their broker

The Day Trader

There are numerous day trading styles available; each with different objectives, but what they all have in common is that any open positions are exited before the market closes. Day trading simply means to enter and exit a position within the same trading day. In fact, any market participant who enters and then exits before the market close is day trading. These market participants include the NASDAQ market makers, NYSE designated market makers, professional traders and stock traders.

Bid-Ask Spread Trading

The market makers trade the spread between the Bid and the Ask. While they have winning trades and losing trades, on average their profit is simply the difference between the Ask and the Bid. Since this spread is often only a cent or two, their profitability is dependant on trading volume.

Some stock traders prefer to trade in this style. They typically use an ECN (Electronic Communication Network) as their order placement venue. To trade the Bid-Ask spread, the stock trader typically places a relative order to buy on an ECN - a relative order automatically amends the limit price so it tracks the market. When the buy limit order is filled, the stock trader places a relative sell limit order. If the sell order is not filled before the market close, the stock trader amends the limit order to a market order to ensure their sell order is filled by the market close.

This style of trading is extremely active and requires the stock trader to constantly monitor the market throughout the trading day. Inexperienced traders find this style of trading difficult to profit from since the market makers have a tendency to take advantage of them. After all, this is the domain of the market makers and they don't like the extra competition as it impacts on their own profitability.

Scalping

This is a form of day trading which takes very small profits frequently throughout the trading day. The scalper will typically buy when an intraday resistance level is broken and sell their stock soon after. Unlike the bid ask spread trader, they frequently buy at the asking price rather than waiting to be filled at the bid. That is they place a market buy order.

They often use a profit target for their exit price but generally don't use the standard chart pattern profit targets. The scalper's profit target is generally much lower for a long side trade and they base their target level on the probability that the stock will at least reach this price level most of the time. Therefore this trading style requires a very high %winning rate to trade profitably. This is because the profits are very small and the loss from a losing trade is usually much more than the profit from a winning trade. Should the stock trade down to their stop-loss level for a long side trade, the position is immediately exited. Scalpers are also very active with short selling.

Some scalper's use an intraday momentum based tactic where there hold there position for as long as the stock's price is moving in their trade direction and exit as soon as the stock shows any sign of reversing or even stalling. Typically these scalpers do not use a trailing stop-loss as such since they are constantly ready to exit their position.

Scalpers generally use bar charts for their trading with the common time frames being one to five minute bars.

Like the Bid-Ask spread trading style, scalping is extremely active and requires the stock trader to constantly monitor the market throughout the trading day. The scalper needs to have a strong mindset as just one losing trade will wipe out the profits from numerous winning trades.

Trend Trading

This is the common style of day trading which most non-professional traders utilize. When the financial press refers to day trading, they are usually referring to intraday trend trading.

All the technical analysis concepts from a daily bar chart can be used with an intraday chart. As such there is an immediate familiarity with this style of trading which no doubt contributes to its popularity. In fact, for the most part intraday trend trading using a five minute bar chart with a liquid stock is identical to trend trading using a daily chart. Some market participants even call this style "trend trading on steroids".

An example of an intraday trend trade using 5-minute bars is shown in Chart 1. The entry is taken from a pullback with a profit target based on the morning rally's relative low to high. The profit targets used for daily chart patterns are also applicable to intraday chart patterns.

Chart 1. Day Trade - Intraday trend trading

day trader stock chart showing intraday bar chart for a day trade with MRVL

The trading day shown in Chart 1. above is shown below on a daily chart.

Chart 2. Corresponding Daily chart

day trading end of day candle stock chart used to locate trades with daily bars for MRVL

Day traders typically use daily charts to search for potential day trades and then use intraday day charts to locate a suitable entry point. As Chart 2. above shows MRVL gaps up at the open after a strong close on high volume from the pervious day.

Compared to trend trading using only daily charts, intraday trend trading is quite active and requires the trader to constantly monitor the market to look for position entries and to continue monitoring while their positions are open.

The intraday trend trading strategies that are commonly used are essentially the same as the daily swing trading strategies and the position trading strategies. The only difference is the time frame of the bar chart.

Day Trading - picture of a stock price quote and watch list on a phone used by day traders to place their orders to buy and sell

Other Day Trading Tactics

The three styles of day trading discussed so far are the more popular styles that day traders use. While there are numerous other tactics that are used by day traders, they are not commonly used by retail traders and tend to be used by the professionals.

Some of these tactics involve using computer programs which make the buying and selling decisions. This is an automated style of trading where the computer program places the buy and sell orders rather than the day trader manually entering the order details. These computer programs monitor the markets for trading opportunities by scanning through the data and the program responds when the preset parameters are meet. The computer program style of trading is usually combined with systems trading.

Systems trading is a style of trading that uses a computer program to back test historical data with the aim of locating trading parameters that worked reliably in the past. These parameters can then be used for locating future trades which is usually also done with a computer program (since a computer program was used to locate these parameters in the first).

Short Selling

When short selling a stock and buying the stock back on the same day, the day trader avoids paying the short interest fee since they do not hold overnight. The overnight hold is what the short interest fee is calculated on. This makes short selling cost effective for day traders.

An example of a short day trade is shown below in Chart 2.

Chart 3. Short Selling - Day Trade

day trading stock chart intraday bars over two days with declining trend for short selling stock JKS

As Chart 3, above shows JKS trades down through a support level setup from the previous day.

While short selling is generally considered high risk as there is no limit as to how high the stock's price can go. With day trading, this risk is reduced since intraday stocks tend to go up and go down by the same amount on average.

Intraday Index Direction

The profitability of all day trading strategies is largely dependant on the market indices. As a general rule it is easier and more profitable to trade in the same direction as the market indices. The main market indices are the DOW 30 industrials and S&P 500 from which a day trader can gauge the general market mood for the day. When trading a NASDAQ stock, the NASDAQ composite or the NASDAQ 100 indices are useful. The NYSE composite index is a useful index when trading NYSE stocks.

Day Trading - picture of a stock chart with a bright blue background with the word trade in large font white capital letters across the screen width with the letter A in red

Time of Day

The early morning is generally the most volatile time of the trading day. The first 10 to 15 minutes after the market opens will often provide the biggest moves but also has the largest bid-ask spreads. This works to the advantage of those who trade the spread or who place limit orders but works against those who place market orders. After the initial opening, the bid-ask spread will typically narrow considerably and then tends to remain fairly consistent throughout the rest of the trading day.

The last half hour can also be a busy time with trading activity which can lead to some significant price moves which may even be in the opposite direction to what was anticipated. The lunch time period can be the quietest time of the trading day.

Summary

For the most part day trading is extremely time consuming which not all stock traders have or are prepared to spend. Most day trading strategies involves having to monitor the market throughout the trading day. Day trading is attractive to those who have the time to monitor the market during the day.

Day trading is generally only a moderate risk so long as all positions are exited before the market closes. Day trading becomes very high risk once open positions are held after the market closes. The intraday price movement is generally fairly minimal and the profits and losses are both small. However when a day trader holds a position overnight they face the risk that the stock will open considerably higher or lower which can lead to an extremely large profit or an extremely large loss.

Most of the risk that comes about from day trading revolves around the fact that a lot of beginner day traders are happy to exit their winning trades but are reluctant to exit their losing trades (usually in the hope that prices will come back and allow a breakeven exit). The problem this creates for the day trader is that their profits from the winning trades are small, but if they hold losing trades overnight they run the risk that the stock continues to trade against them thus making what was a small loss into a big loss.

Brokerage commission costs are a factor that day traders need to consider since the profits are small and brokerage costs can quickly turn a profitable strategy into a net losing strategy. Also day trading accumulates a large number of positions over time which increases the amount of work needed to locate proposed trades and to record the completed trades.

Some stock traders are happy to day trade while others prefer to trade with a longer time frame such as swing trading or position trading which provides a more relaxed trading style. For those who still prefer a longer time frame they might find speculative trading more appropriate. Speculative trading is essentially a combination of technical trading with fundamental considerations and is sometimes referred to as fundamental trading.

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