Day Trading Strategy Basics

Bar Graph Help Day Trading Strategy Basics

A good day trading strategy needs to have clear entry and exit points. You should also have a clear profit goal, at which point you will exit once you achieve that goal. However, the most important aspect of a successful strategy is having a clear stop-loss exit point.

A successful day trading strategy also needs to be realistic. If your strategy is to exit once you make a 5% gain on a stock that barely moves 5% in a day on average, then your chances of success are extremely low. One reason is because we cannot accurately predict what will be the lowest point of the day, nor can we predict how much the stock will actually move today. You will be waiting forever on that 5% while you lose money.

Some traders also have mental stop-losses for daily losses. If several trades go against them, once the losses reach a certain point, they will stop trading for the day. Inexperienced traders will often continue to trade as the stress makes them make worse and worse decisions. Emotion and greed will destroy you and your finances if you aren't careful. All traders must learn how to develop their skills at both risk management and stress management.

Related: Stocks vs Forex: Why Trade Forex?

Day Trading Strategy: Entry Points

Many day traders use candlestick charts in order to establish entry points. There's a whole study behind the meaning of the different candlestick shapes created by trader activity. However, the basic idea is to enter the trade when the price is just beginning to reverse. If you are buying stock, then you want to enter as soon as it appears that the downtrend is reversing into an uptrend. If you are short selling stock, then you need to wait until the uptrend reverses back into a downtrend. Certain candlestick shapes provide the appropriate reversal signal.

However, additional information like the monthly trend and the recent daily trend will also give you insight into a stock reversal. If the monthly trend is a downtrend, then you will need to be cautious when entering into a trade by buying stock long, because the whole day may go mostly down with only minor uptrends. Ideally, short selling stock is a better entry strategy when the monthly trend is going down.

The recent daily trend can also provide signals for a reversal. If the stock has regular ups and downs during the day, then whenever the price nears a recent high or low, we know that it is either about to reverse or make a breakout. There are traders who only trade breakouts, which is when the stock price goes beyond a support or resistance level. However, these types of trades are not as common as just trading the regular volatility waves.

Day Trading Strategy: Exit Points

Beyond deciding when to exit in order to make a profit, it is absolutely essential to establish a stop-loss point. This is the point at which you decide to get out of the trade if it goes against you. Your stop-loss should represent the most amount of money you are willing to lose before you decide to exit the trade.

Set a stop-loss, and obey the stop-loss. If you buy the stock, and then it immediately hits the stop-loss after you buy it, then sell the stock. Do not hold onto it, because it may be that you were wrong about the reversal and the stock is going to continue going down.

It is also a good idea to create a mental trailing stop-loss. For example, if your stop-loss is -1% but then the price goes up by 1%, your new stop-loss should be the original purchase price. If the stock goes up to 1.5%, then you can make the new stop-loss 0.5% and so on.

As the stock price increases, you raise the stop-loss by the appropriate amount. If you are trying to achieve a 2% gain and it goes up to 1% but then drops down to the original price (which should be your new stop-loss based on the 1% gain) then sell the stock. Yes, you make no profit but at least you do not lose anything (except trading commission fees). If you are going to aim for 2%, then that's the risk you take: ending up with no profit.

Day Trading Strategy: Profit Goals

The lower your profit percentage goal, the more often your trades will be successful. If your goal is to try to achieve a 5% gain every time you trade, then your failure rate will be very high even if you trade stocks with an average daily volatility above 5%. However, if you are satisfied with a 1% or even a half percentage profit, your chances of making a successful trade will be significantly higher.

Day traders who making a living from trading will often gain only 1% on the stocks they trade. Even day traders who claim to make $1,000 in one day are trading thousands of stocks with roughly $100,000 in order to make that $1,000 profit.

Day Trading Strategy: Why Day Traders Lose Money

The biggest mistake beginning day traders make is not having a stop-loss exit strategy, or not following it. As the trade goes against them, they fail to accept their losses and sell the stock. Sometimes they even add to the trade! Day Trading is all about risk management. If you fail at risk management, then you will fail at day trading, because trades will go against you.

What will you do when you fail to exit the trade and it drops continuously the next few days until you've lost 10% or even 20%? You may think the stock will recover eventually, but this could take weeks, months, or even years to fully recover. If you are going to day trade, then you have to learn when to accept your losses and get out of the trade. A poor exit strategy is a primary reason why traders lose money. Sometimes traders do have an exit strategy, but then they ignore it once they are in the trade.

Following a good strategy is what will win you the game, not your emotions or instincts.

Emotions are another big reason why beginning day traders lose money. What is the point of having a strategy if you are not going to follow it? All you need to do is get in the trade, get your 1%, and exit the trade. If you buy a stock and the price drops immediately to your stop-loss, then immediately sell it. Eliminate your emotions by just following the rules you have established.

Read How it Actually Feels to Day Trade

Stocks vs Forex: Why Trade Forex?

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