This article was written by Alexander from daytradingz.com | Alexander started investing back in 1999 and his fascination with the financial markets is still strong today. He started his blog in 2016, sharing his experiences in short term investing as well as revealing insights about major vendors in this segment.
Success in day trading – Truly easy, or is that a myth?
It is widely known that a long-term and conservative investment in capital markets (such as index certificates) historically offers good returns of 6-8% on average.
Nevertheless, the short-term trading in small time units, so-called day trading, attracts many investors. Why is that so, and how can you best prepare yourself for day trading? You will find out in this article.
What does day trading actually mean?
It’s really very simple. Investors who buy and sell securities within the span of a day are day traders. The goal of a day trader is to take advantage of the smallest price fluctuations to make a profit throughout the day.
But stop, small price fluctuations, how could that be worthwhile?
The gains that can be made from day trading are very much dependent on the amount of securities traded in a securities transaction. Only active control of the traded quantities results in significant profits. When I buy, to give an example, a stock for $20.20 and then sell for $20.30, it requires at least 1000 traded shares in order to have made any notable profit ($100).
The danger of large numbers
That sounds pretty good, right? But this is exactly where a first trap lurks in day trading. Because finding a buyer or seller, namely your counterpart for your stock market business, is not so easy with high quantities.
There are stocks where the daily turnover is well below 1000 pieces. That is why they are ruled out for trading right from the start.
In conclusion, a first necessity for successful day trading is a corresponding security that has a high daily turnover in terms of the number of units.
But what else is important?
The fluctuation range of a stock is crucial
Another very important aspect is the fluctuation range of a share within a day. If for example one share is quoted at around $20, but fluctuates only by 0.5% per day, that is, 10 cents, then it will be very difficult to retract 10 cents profit with a trade. For this, the investor would have to buy at the daily low and sell at the daily high.
As a second ingredient for successful day trading we need volatile securities.
However, it would be far too easy for a large number of high-fluctuation stocks traded daily to be the only prerequisites for succeeding in day trading.
Spread is especially important
The spread, what’s that again? Exchange trading is based on supply and demand. There is a certain maximum price that an investor is willing to pay for the securities being targeted (per piece) and there is a minimum price at which a current holder of a security is willing to surrender his security.
These two price points are called BID and ASK.
The difference between BID and ASK is called spread.
But what impact does the delta from BID and ASK have on my success as a day trader?
Well, that’s easy. If you want to invest your money and prefer a quick execution of your trade, then you will most likely receive your prize at the ASK as the execution course. If you want to sell your security as soon as possible, then you will usually only get the price of the BID.
Buy 1000 shares at 10 o’clock in the morning. BID: $20.10 ASK: $20.30 – Execution 1000 * 20,30 = 20,300 Investment amount.
If you now want to sell immediately after getting started, but BID and ASK are unchanged, then the result looks like this:
Sell 1000 shares 10:05 am. BID: $20.10 ASK: $20.30 – Execution 1000 * 20,10 = 20,100 money in the bank.
As you can see, with this quick buy and sell you would have lost $200 within 5 minutes. Not a comfortable thought, right?
That’s why it’s important to trade securities that have very low spreads whenever possible. As a small reminder you may note that the spread should not be greater than the target profit in cents per share.
Otherwise, you‘ll make losses right after the purchase and reach the potential profit range only if the BID increases sharply, or you can raise your offer and have it bought back highly.
What did you notice in this example? Yes, there are fees. How does this look in real trading?
Fees – the 4th Important Factor in Day Trading
Those who invest long-term and hold securities for several months or years certainly do not need to worry about order fees when buying and selling securities. However, if you buy and sell thousands of shares several times a day, you should take a closer look.
5 purchases and sales per day = 10 trades
10 trades * $5 order fee = $50 order fee per day
10 trades * $10 order fee = $100 order fees per day
You‘re with me so far?
Delta between cheap and expensive order fees at 10 trades a day: $50
Trading days per month: 20
Difference applied on the whole month: 20 days * $50 price advantage = a whopping $1000 saved!
Now we start talking, right?
As you can see, the order fees are crucial. Many day traders dream of earning $1000 a month with day trading, so why give the money to the broker?
Is it realistic to do 5 purchases and sales per day?
Yes, sure. For a day trader it is quite common to make 10 or 20 purchases and sales and sometimes even more. That makes it worthwhile taking a closer look at your online broker fees – for example with a broker comparison.
Additional Information no. 1: How do I locate suitable entries and exits as a day trader?
That’s a very important question. In any case you should not consult a self-proclaimed guru. Rather, you should use stock screeners to track down the appropriate securities daily.
It is easy to fill in the criteria described in this article. Especially as a beginner, you should take care to use cost-effective and therefore preferably free stock screeners such as the Yahoo Stock Screener, or the free trial versions of high-end stock screeners such as the Trade Ideas Stock Screener based on artificial intelligence. Save where you can. Once you have found the trading tool of your choice, you can still invest in a monthly subscription.
Here you will find an overview of the 10 most popular stock screeners, with descriptions of functionality, pros and cons, the evaluation of their value and the respective prices.
Additional Information no. 2: Should I begin with real or virtual money?
Yes, the thrill to get started right away with day trading is enormous, but as tempting as it is, it’s just as dangerous. That’s why you should always invest only a small part of your available capital. If you lose all the capital invested, this should not leave a significant trace.
I am serious! Day trading is extremely risky. According to recent findings, about 80% of investors lose their money in speculative trading. The most common reasons are bad preparation, greed and the unreasonable use of equity.
How to protect yourself?
That is quite easy. Trade first on paper. You can do this either with a trading app (with virtual trading dollars), or start out the classical way using a pen and a piece of paper. Remember, if you cannot make profits over a long period of time with paper trading, then you’ll probably never do so with real money. Trading in real money comes with much larger, mainly psychological challenges.
Additional Information no. 3: Are high frequency traders day traders as well?
There are high frequency traders who buy and sell securities within fractions of a second. High-frequency trading usually takes place fully automatically and aims to exploit the smallest differences in price with correspondingly high quantities of securities. Here, primarily shares are traded.
Yet high frequency traders are not typical day traders, even if the purchases and sales take place within one day. Do not be misled by various promises. High-frequency trading is only for institutional investors who keep their server farms as close as possible to the stock exchanges.
Because that’s where execution speed counts and we talk about fractions of a millisecond that decide whether the trade is profitable or not. Before you have placed your order in the system, the high frequency trader is already out of 10 other trades again.
Day trading is not a game, it’s a job! Like any job, ambition, discipline, resolve and a certain level of skill are critical to long-term success!
TFC Disclaimer: Guest posts are posted in good faith. I cannot attest to the originality of each article. If you have any concerns about the content, please contact the author of the article outlined above.