After understanding the need for risk and money management rules to protect capital because day trading relies on quick, accurate movements rather than long-term trends, traders have different trading strategies to rely on. Traders should consider using more than one trading technique to diversify risks. These trading strategies include moving averages, the MACD and reversion to mean techniques.
Moving Average Strategies
Moving averages are constructed by taking the most recent bars (periods of time measurements--bars can represent seconds, minutes, days, weeks or months) and averaging the prices. Among the more common tools are traders who purchase stock when it rises above the 50-day or 200-day moving average. More importantly, traders test different stocks by using a long-term and short-term moving average. The long-term moving average establishes the long-term trend and the short-term average establishes an immediate movement. Traders buy stocks when the short-term trend rises above the long-term trend. Traders sell when the averages reverse themselves. Traders use moving averages for intermediate and longer moves that may last the entire day trading period. Sometimes a third, long moving average is used to further establish the quality of the long-term trend. If the long-term trend is bullish, any short move downward is likely to be brief and inconsequential.
MACD as a Day-Trading Strategy
The MACD, or moving average convergence divergence indicator, was developed by Gerald Appel. Appel, himself a trader, wrote 13 books relating to trading strategies, including "Winning Market Systems," "Double Your Money Every 3 Years" and "Stock Market Trading Systems, and New Directions in Technical Analysis." The MACD compares two moving averages, the 26-day and 12-bar moving average. The result is then reformulated into a 9-bar or signal line. The MACD will turn positive or negative, indicating a change in market direction. The 9-bar signal line is used to indicate peaks and bottoms. The MACD is a popular trading tool. It can be subject to distortions, however. Because, in essence, the MACD is a moving average, there is necessarily a lag in new signals. Also, sometimes the signal reflects not a change in direction but a pause in the direction of a trend before it gains strength again. Some traders use different moving averages and compute a MACD, based upon longer and shorter trends.
Reversion to Mean Techniques
Reversion to mean techniques are another popular day trading technique. Stock prices trade in statistical ranges that are usually near the current price. Sometimes during strong bull and bear moments, prices trade at extreme prices from the statistically probable price. If the stock price is too high, say 4 standard deviations above the mean, the day trader will short the stock and recover when it reaches a more suitable measure. When prices are too low, statistically the stock will be bought then sold at the mean. These are short trades, sometimes lasting only a few minutes, but they are popular trades as it is unlikely for a stock to stay at an extreme price for long. Trading mean reversion is also a good way to diversify trading styles, if, like most day traders you tend to be long only a few few stocks throughout the trading day. Traders can readily compute the amount of reversion to take place and have immediate price targets.