Day Trading PROs and CONs
by Tony Ponzo
What is day trading? Day trading is the buying and selling of a stock or an option in the same day. No - that doesn't mean making a fortune in one day. But it does mean making steady profits each day. In most strategies, the buying and selling of a trade happens quickly - sometimes within minutes. Small and quick profits are usually the goal of a day trader and making several of these small profits will add up to an overall healthy total by the end of the day. Astute day traders have a specific goal in mind. For example, the goal may be to keep trading until a $1,000 profit for the day is reached. That may take one to three trades to make that goal or it could take up to 6 or more trades. A goal could be reached in the first hour or two of the market or it could take all day depending on the success of the trades and the ease or difficulty in finding and entering trades. A day trader understands that not every trade is going to be successful. So, when a trade or two is unsuccessful, the trader has to get back in and try to make up those losses. This is just part of the job.
In picking a stock to trade, there has to be an impetus that a trader believes will make a stock take a an extraordinary run up or down for the day. You can play a trade up or down which gives a lot of versatility. For example, a stock might have an earnings announcement in the morning before the market opens. If the earnings report is exceptionally positive, a trader may decide that the stock is going up. Or a stock could have an upgrade or downgrade. Whatever might move the stock in an extraordinary way is what most day traders look for. It's important to watch the up and down patterns of the stock once it starts trading and get a feel for the right time to go in.
Some traders use technical assistance to determine the time to go in. A real-time chart that employs indicators, such as Moving Averages, The Williams, RSI or Stochastics is a tool used by many day traders. IQ Charts is a real-time chart program worth looking at. Usually with the moving averages, two averages are compared to each other. When the shorter term average goes above the longer average line it would indicate an up play and visa versa. Because this is a fast play the two averages are set for very short periods. Also, the time of the chart might be a two minute chart or a 5 minute chart depending on the preference of each trader.
Once in the trade, it is best to have a goal price to get out and immediately put in the order to close. That goal may be .50. For example, if a trader enters a long trade on XYZ stock at $39.76, an order to sell would immediately be placed at $40.26. (XYZ buy @ 39.76 at 9.30 AM; sell @40.26 at 9:46 AM = .50 profit)
Conversely, if a trader shorted a stock (thinking it is going down), an order to buy back the stock at .50 lower would be placed. With options, of course, CALLs are for up plays and PUTs are for down plays.
The closing order could be executed in seconds or it could take hours. It could also go against the play. No matter how well one has studied and thought out the trade, sometimes it just doesn't work. Therefore, it is of utmost importance that an exit plan to get out at a maximum loss is decided upon in advance, should the play go bad. That might be .50 to the down side or .40 or whatever the trader feels comfortable with. This can be nerve wrenching as the price of a stock can move up and down and fast- like a roller coaster. But these goals and exit strategies are an extremely important part of the strategy. Sticking by these goals is the way to success. When one loses, it is also important to get right back into a new play and to keep working until the day's goal is accomplished.
Now, trading stocks may be too expensive for many traders, so that is why many traders choose to trade options instead. The leverage is so great that the percent of return is extremely increased. One trade can bring a 10% profit or more. That's 10% in minutes in some trades. When annualized, this becomes a percent gain that is in the hundreds. For example, if one trades a CALL option and pays $3.00 for that option, ($300 per contract) a .30 profit is 10%. If the 10% or .30 profit is made in 30 minutes, the trader frees up that capital and can use that same capital again to make another trade - then another and another and so on. So let’s see what that means if a trader goes into three successful trades in the day making the same $3,000 investment each time.
Assume the trader buys 10 contracts of XYZ for $3.00 a share or $300 a contract. This would be a $3,000 investment as I stated above. In 30 minutes, if the option did what was expected and the trader gets out at $3.30 a $300 or 10% profit has been made. Now, the trader can use the original $3,000 to go into the second play and is out with another $300 profit. With three successful trades for the day, the trader has $900 of profit and all made on the same $3,000 and that equates to a 30% profit for one day!! Not bad for a day’s work. Of course, you are not going win three plays in a row everyday as we state above, but it will happen from time to time and when it does, it brightens up your entire day!
Lastly, before one embarks on day trading, they should know and understand the Pros and Cons.
Pros
- Traders complete all trades everyday and start fresh the next day. Sometimes the daily goal can be hit in only a few minute or hours.
- A high percent of return can be made quickly, especial when using options.
- When one becomes proficient enough in day trading to maintain a consistent profit, it can become your main source of income - potentially earning one a significant amount of annual income!!
- Hey, if you want to take a day or two off because you have done so well, who is going to stop you? You’re the boss!
Cons
- Due to the quick nature of day trading and the uncertainty of the overall market, making decisions of when to enter a trade can be very trying. It takes a certain personality to do day trading and one needs to learn to take the emotion out of it and play according to the targets and goals that have been set in advance, as mentioned above.
- If a play goes against a trader and action is not taken to cut the loss in time, losses can mount quickly. Then it becomes harder to make up those losses.
- Day trading requires concentration and quick decision making.
If day trading interests you there are many sites you can check out on the Internet for additional information and strategies. Here at SplitMaster.com we have developed the Momentum Strategy specifically suited for day trading and based on earning announcements and SPX index options. Be sure to check it out!