Is Day Trading For You?
The following article is written with the intent of highlighting what I consider to be important elements specific to day trading. The eight points which I expand upon giving an overview of the day trading process and its requirements, to aid you in deciding whether day trading as a profession is right for you or not.
1- Markets — The first and foremost consideration for day trading is the market selection. Not all futures markets provide an opportunity for day trading. Markets with low intraday volatility do not generate enough price movement to justify commission costs and potential profits. A day trader needs to seek markets with high intraday price volatility and change. Based on previous research of market volatility the financial markets such as the S&P 500, Treasury Bonds and Currencies present best vehicles for day trading.
When discussing volatility, we need to consider a few different concepts carefully. Without getting bogged down with too many technicalities, I call your attention to the following: Volatility refers to the rate of change on an intraday or daily basis. As a day trader, your interest lies in which market offers the widest price swings in a day. The following example demonstrates how high levels of volatility can also be a “two-edged sword.”
The S&P 500 futures market on average moves between 16 to 25 points per day. This is based on research of S&P daily price ranges from 1994 to 1997. The data shows us that if we have the right methodology and systematic approach, we can certainly make a considerable amount of money in this particular arena. However, the very same market is also capable of exhibiting wild, extreme and violent intraday swings.
As an example, examine small time frame bar charts (1 through 5-minute) and observe how much price can change in so little time. Three-point moves ($750) can be found on 3-minute bars at times — which is great for profit but must also be viewed as a potential risk. This volatility translates into the fact that we are capable of losing $750 to $1250 in minutes – which is way too risky for my equity capital. In short, we must learn to distinguish and clarify what we mean by acceptable volatility. Gauging volatility in a market helps us to maximize our profit potential and minimize our risk.
Based on research, markets like the S&P 500, Bonds and Currencies offer the best conditions for day trading with regards to volatility, liquidity, and access. Of the three groups, the S&P’s have gained the reputation and recognition as being a true day traders market. It is composed of approximately 85% daytraders and 15% position traders. The following points discuss the distinct differences between day and position trading.
2-Technical vs. Fundamental – Daytraders rely heavily upon technical indicators – as a contrast to the position trader who makes use of fundamental leading indicators. Tricks of the trade for daytraders include specific chart formations, intraday support and resistance points as well as opening and closing prices of the day. For the position trader, however, the intraday activity of a market has less significance than overall market activity and direction. The day trader is more of a Technician — while his counterpart, the position trader is more like a Fundamentalist.
The daytrader may choose to utilize a variety of technical indicators for the decision process of entering and exiting trades. There are over 100 indicators available for all the charting programs marketed. The intention of these lagging indicators is to help you determine whether a market is in a trend or about to reverse its direction. There are two types of indicators available: Static and Dynamic (also referred to as Adaptive). Static indicators have a fixed input for the variable and its settings are based upon the notion that the market will repeat its past price history and movement identically and repeatedly.
Adaptive indicators attempt to take into account new market conditions and make corresponding changes to input values accordingly. Overall, a typical daytrader relies upon his/her selected indicators for trading decisions — which therefore implies that they reject the Efficient Market Hypothesis and its implication of the Random Walk Theory. (We will expand upon these concepts in future articles.)
3-Profit Target – It’s very unlikely that one will make a “killing” on any particular intraday trade. Day traders look for relatively smaller profits and fewer losses. Position traders, on the other hand, get in and out of many trades, with the hopes of eventually getting in on a meaningful and sustained trend. This means more losses of small value with a lower percentage of winning trades overall – but significant profits on winning trades to offset the costs of “finding” the best entry point. Overall, the mathematics for each of these trading styles are quite different. When you evaluate a daytrader or day trading methodology, you need to see a higher percentage of winning trades with relatively small losses. The position trader will typically have a higher frequency of losers that are small, but much larger profits on winning trades.
4-Capital – The capital required for day trading is substantially less than for position trading. For every contract you take on as a position trader, you need to post margin in your account, as required by the exchanges. Trading the same market and assuming the same strategy on an intraday day trade will typically require much less capital for margin.
For example, a position trader needs to have a minimum of $12,600 per contract to trade the S&P with overnight positions. The day trader is able to post half that amount (and sometimes even less) for his intraday trades. This means that as a day trader, you are able to more effectively utilize your capital than the position trader since your equity can work in more trades at the same time, bringing increased profits to the successful trader.
5-Time Required – Day trading requires more time and attention than position trading. You need to monitor your trades constantly until all positions are closed out. Position trading requires much less time and day-to-day attention. With proper money management, long-term traders can leave their positions unattended for days or even weeks. By contrast, in day trading you will need to watch, evaluate, adjust and change your positions many times during the day. The very nature of day trading and its associated conditions and intensity will preclude the majority of investors from being able to participate due to their regular jobs and commitments.
Although some commercially available systems and tutors boast the ability to day trade markets with little to no intraday monitoring, they should be viewed with caution and suspicion due to the nature and character of the markets. Day trading is a full-time profession and must be treated as such if you want to succeed. Ask yourself the following when you consider the possibility of day trading for a career: can you make enough profit after commission costs, data feed costs, program/educational costs to justify your new endeavor as a trader? Does the potential profit justify your time? The decision to daytrade full time requires serious consideration before committing yourself. Day trading is a career and occupation – not a hobby or amusement.
6-Commission Costs – It will cost you more in commissions day trading than in position trading. In day trading, you might have to enter and exit positions a few times in a given day, whereas with position trading you enter and exit trades with much less frequency. You, therefore, need to look at the cost of “doing business” when evaluating a trading methodology and system. There are many ways to reduce the commission costs incurred when day trading. These include but are not limited to Online trading via the Internet, Discount trading and negotiating with potential brokers when shopping around for a suitable candidate.
As a day trader, you need to get quick and accurate fills. Brokers and their respective clearing firms (FCMs) usually specialize in a few markets, so be sure to select a firm that will cater to your needs. There is no sense in trying to trade the S&P’s successfully through a firm that specializes in agricultural products. Deal with a firm that will be well suited to the trade execution requirements a day trader has. Try to shop around and get floor access – real floor access, as opposed to a trading desk situated somewhere on the floor that can’t even “arb” in your trades with a hand signal during fast market conditions. Some may argue the quality of fills may not be a crucial factor in the overall success of a trading methodology. I agree – but it helps a lot in the long run and makes your trading seem easier.
7-Equipment Requirements – In day trading, active participation in the trading process requires a real-time data feed and charting program. The cost of these essential components can be quite substantial. In position trading, you don’t need access to real-time data — and in some cases, delayed data is even unnecessary. You may be able to obtain your information from one of the financial newspapers like the Wall Street Journal or Investor’s Business Daily.
When considering which of the real-time data vendors to chose as your source, do your homework and shop around for the fastest, most reliable and affordable. Depending on which market you trade, you might be able to access your data through the Internet at a lower price than the satellite or cable alternatives. Be sure to check for compatibility between your data vendor and the charting program you choose. There is a wide variety of charting programs available to day traders and their cost will correspond to their sophistication. Some of the real-time vendors even provide you with their own “in-house” charting program. Regardless of the developer, they all have a multitude of STATIC indicators to choose from.
8-Personality – More important than anything else mentioned above, the personality of the trader plays an important and crucial role in successful trading. You need to have a deep and insightful understanding of your character and personality traits. Is your makeup best suited to position or day trading? Are you even suited to be a trader at all? The reality of the trading world is that you don’t just trade the market — you trade yourself in the market. If you don’t know yourself well enough to identify your strengths and weaknesses, trading will assist you – but at a high price. It would, therefore, make sense to try a few of the popular personality tests to identify and become more conscious of your strong and weak points.
We all have positive and not-so-positive traits in our personalities. Like everything else in life, the key to success is building on our strengths — not fighting against who we are by trying to change our undesired traits. For example, if fast decision making is problematic for you, then you should consider position trading to be more suitable than day trading. Or if you’re a great procrastinator, you must make sure that your entry order is accompanied by a protective stop loss order, to ensure that a losing trade is not compounded by your natural reluctance to “put off” the proper decision. This is a personality trait that can run you out of trading — and your equity — very quickly.
You might also find out (possibly through one of the personality tests if you are currently unaware) that you are the type of person who constantly strives to be the best and most perfect at your trading. Let’s label this type of person as the Perfectionist. This type of trait can cause a lot of problems and big losses for a trader.
The Perfectionist tries extra hard to not have any losing trades. Unfortunately for him, this only means more disastrous losses. Multiple consecutive losing trades handicap the Perfectionist from taking the next trade because he’s now gun shy and scared to pull the trigger again. The result – more lost opportunities.
A crucial factor in being a successful trader is to recognize and believe with your heart that trading is a game of probabilities. Sometimes you win and sometimes you lose. You can separate yourself from the losers by formulating a trading plan that helps you reduce losses while maximizing gains. Proper stop loss placement and optimal management of winning trades are keys to winning at the probabilities game.
Most of the time we tend to forget that we make our decisions with our emotions and then justify with our logic. The assumption of rational investors in the Efficient Market Hypothesis couldn’t be further from the Truth. On the contrary, when it comes to trading we all become quite irrational. In behavioral finance, the notion of the irrational investor is the norm.
In trading, more than anything else in life, we rely heavily on our emotions, either through unrealistic and ultra-optimistic profit and fortune goals – or pessimistic and hopeless expectations based on our previous experiences. Rather than thinking in the Present, we often think in the Past (with our past experience associations) or in the Future (with a desirable and idealistic outcome perception). To remain focused on the Present and judge our trade as it unfolds Now, requires practice. But more important than practice, you must know who you are and understand your personality first.
Trading is like a clear mirror that reflects our inner personality and character. It is not only capable of bringing us great financial rewards — it can also help us to know ourselves better. This benefit can greatly contribute towards our evolution as better individuals and human beings. This is one of the most important reasons I have cultivated a love for trading. It is the ultimate endeavor for a free and beautiful life.
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