To be sure, there are many, many criteria one may use in choosing stocks. Company assets, debt, earnings, health of its market sector, management, size- the list goes on. The
instructor asked the class to come up with as many as possible, and told us that all of them were valid. He then totally shocked us by saying that he didn’t take ANY of them into consideration when when deciding to buy a stock. As for “stock tips,” he said that whenever someone recommended a stock to him, saying, “It’s a great company,” his response was, “I DON’T CARE!!” Then what did our very experienced and successful instructor care about, when choosing a stock? When picking stocks for day trading, all he cared about was technical analysis.
Technical analysis is simply the study of the graphs and charts of individual stocks. By studying the past and comparing to the present, we can estimate the odds of probability looking forward. We spent by far the most amount of time in this course learning to read charts and identify trends and patterns. “The trend is your friend,” it was stressed to us. First of all, day traders should be seeking stocks that have a high Average True Range (ATR), or spread between their highs and lows of each day. Let’s say a stock is trading around $30 per share, and its ATR has consistently been about $.80 per share each day. If you bought and sold, say, 500 shares in the same day, using technical analysis to prudently guide your entry and exit points, you could make $400 on that trade. Traders set up their own criteria for determining what and when to buy and sell. All the major stock brokerage firms now have free programs and classes, not to mention excellent software, to help you in the process. Such programs were not available years ago, mainly because trading firms would rather keep such information to themselves, along with the big commissions! All such firms now offer mock trading programs, where you can “dry trade,” doing virtual buying and selling without using money! It gives you the terrific opportunity to make or lose money on paper, without risking a dime, until you feel confident enough to begin actual trading.
With their software programs, you can set parameters for what YOU are seeking in a stock, and they will automatically sort out the candidates. One such parameter should be liquidity. The more shares of a stock that are traded every day, the more likely your buy or sell order will be filled promptly. We were taught that day traders should not trade stocks with a volume of under 500,000 shares per day. Then there is the question of price. I like to buy stocks that are relatively cheap, so I can afford to buy more shares. A stock that is trading around $30 per share, with an ATR of .80, is more attractive to me than a stock trading at $65 per share at close to the same ATR. There is a lot of personal preference involved in trading, and one must create and stick to their own set of rules.
So how accurate is using technical analysis and day trading? The very BEST day traders can be wrong on more trades than they are right, yet still create handsome profits. How can this be, you ask? It’s because one minimizes their profits which maximizing their gains. As we discussed, one will place protective stops on each trade, set at one’s tolerance for risk. In my previous column, I gave an example of setting a stop for a 2% risk, which amounted to a potential loss of $200 on 1,000 shares of a $10 stock. Some may set the stop higher or lower, depending on their tolerance for loss. OK, so you were stopped out at a loss of $200.00. Now let’s say the same stock goes up $.52 that day instead. Your trading rules told you to place a limit stop at $.50. When the stock reaches that goal, the stop triggers a sell, and you made $500.00 on that day trade.
Obviously, the entry and exit points are critical, and a good study and practice of technical analysis will prepare you to make good choices. I have spoken with a number of traders who actually set profit limits for themselves each day. A classmate who became a proficient trader, and with whom I correspond, told me that she has a daily profit goal of $500.00. If and when that goal is reached, she sells and stops trading for the day! She says she wants trading to be enjoyable, not compulsive, and is not interested in becoming a slave to it, as it can be addictive!
So, yes- day trading (done properly) IS the safest way to invest in the stock market. Whether you experienced a small loss or a nice gain, by being out of all trades at the end of the day, you have totally controlled your risk. I hope these very basic guidelines prove useful to you, and I cannot emphasize too strongly the importance of taking advantage of the excellent- and free- educational programs available to traders via the brokerage houses! While I am happy to answer general questions, a number of readers have contacted me with requests for more specific advice, which I am prohibited from offering, as I am not licensed to do so. Try one of the outrageously helpful “virtual trading” programs, and see if you like it. Oh, when I think of the money I would have saved, were such tools available to me when I started!
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