Strategies for Day Trading
Day trading strategies begin with a risk plan, a money management plan, and strategies for buying and selling stock. Good day traders have a master strategy that incorporates all these areas of trading. Successful trading plans reduce drama by knowing before the trade how the strategy will be implemented.
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Risk Strategies
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Day traders necessarily hold and trade just a few positions at any time. This is because those few trades are followed intensely and not allowed to fall below certain tight risk parameters before they would be sold. It is hard for a day trader to manage more than three or four positions at one time during the day. Day trading risk strategies avoid diversification, choosing instead to closely monitor active situations that have immediate profit prospects. Normal stock trading relies upon the fact that a stock in a positive trend will, on average, gain each day more than the day before. Since day traders sell all positions at the end of the day so as not to incur overnight risk, diversification by sector, asset class or industry is impossible. Day traders trade momentum, not value or growth prospects.
Money Management Strategies
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The risk allowance per trade employed by day traders is very small. Good day traders use predetermined limit or stop losses that prevent small losses from becoming large losses. Traders use money management because they understand that for every 1000 trades it is very likely that they will have 10 or more consecutive losses several times. Keeping the risk per trade low, especially when using large amounts of capital per trade, is the only way to weather consecutive losses. Good money management strategies are absolutely essential when day trading.
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Stock Strategies
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The most popular strategies for day traders involve momentum stocks. Momentum stocks are those stocks that are in increasing favor by institutions, traders and the investment community because of readily apparent competitive advantages. The price action of energy stocks when oil prices are falling or rising sharply is a good example of momentum trading. Momentum traders use stochastic signals and moving averages for most trade entry and exit. Volume is used to confirm a major move. Stochastic signals compare two averages to determine the rate of change of stock prices. When the average turns positive, the trader buys stocks. When the average turns negative, the trader sells the position. Moving averages are used to initiate stock purchases when they trade above certain recognized benchmarks such as the 50 day and 200 day moving average. Traders commit to these trades until the end of trading or unless the stock falls back under the specified moving average.
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