Good morning hope you have a great day trading. Here is my second post from the workbook. If you missed the first post I started a new tab "Workbook for Beginners" I will post a section there each day until it is completed.
Reality Check
So
let’s start by taking a hard look at who we are, what we are working with and
what type of trader/investor we should be. I cannot tell you how many people I
have talked to that have this fantasy of what they are going to do and what
type of trader they are. I say fantasy because their perception of what it’s
going to take to succeed if often flawed and not based in reality. For example
If you have a $6000 dollar trading account and you think you are going to be
able to quit your job and trade full time as a successful day trader you are
living in fantasyland. The pressure of having paying your bills, to support
yourself off of your trading earnings with add to the pressure and potentially
influence you to make poor trading decisions. I am not suggesting you cannot
take a $6000 dollar account and turn it into $100k and pay all your bills. I am
sure there is someone out there that has done so but I would venture to say
that it is few and far between.
It’s my opinion that if you want to be a full
time day trader you need to have a minimum of 25 to 30K anything less and you
have to deal with the PDT. The following is the link for the FINRA website and
it will tell you everything you want to know about the “Pattern Day Trader
“rule.
There are prop trading firms that give you an opportunity to
leverage your capital and enable you to circumvent the PDT rule.
Proprietary (or prop) trading is a high-risk form of trading where instead of acting on
clients orders and receiving commission payments, the trader assumes his own
position with the capital of the firm. This means they will experience the full
profit or loss of the position. Prop trading firms trade electronically and the traders can use the
leverage of the firm to magnify returns (and losses).
For beginner traders, I think this is a bit like handing a
loaded gun to someone with suicidal tendencies. I am not suggesting that you
are guaranteed to fail but the amount of risk you are taking by leveraging up
your account is tremendous. One losing streak could not only wipe out your
account you could actually end up owing money. You need to know your abilities
and your limitations. If you want to start using margin, then you should do so
after you have established yourself as a consistent profitable trader with a
solid trading system, and superb money management skills.
I don’t mean after you have one week of beginners luck as the
market is ripping to new all-time highs. I mean a consistent track record in
good times and bad for no less than one year. This is not a sprint to the
finish line, nor is it a get rich quick strategy.
It’s a marathon, a chess game that requires you to be
methodical in your approach and disciplined throughout the entire process. When
you are first starting out, it should be about how well you are able to execute
your specific style of trade, using a well-defined strategy that you are
comfortable with. You need to evaluate your performance based upon how closely
you adhere to your game plan/strategy and not about your percentage of gain or
loss. Consistency is key, focus on the system and execution; evaluate your
discipline within the process, by using this mindset, you will make it easier
to identify where problems exist so that you can solve them. No matter what style
of trader you are, consistent performance evaluation will greatly improve your
chances for success. The profits will begin to flow consistently only after
after you have established a sound disciplined system.
The four styles of day traders
Scalp traders, Momentum
traders, Faders, Pivot players
Let’s
look at each of the different styles in more detail and see if we can determine
what style is best suited for your personality and risk tolerance. We also need
to make sure you have the necessary amount of time, tools and account size to
realistically pursue that style.
The scalp Trader: The scalp trader typically
works with very short time frames often using 1 minute, 3 minute charts.
Scalpers are looking to take quick scalps out of a stock as it breaks out of
patterns intraday. It requires precise execution and market timing. Scalpers
specialize in taking profits on small price changes it requires them to have a
very strict exit plan since one large loss can eliminate many small gains that
a scalper has worked to obtain. The whole strategy is based on achieving
results by increasing the number of small percentage winners while sacrificing
the percentage size of the wins. They often sell just after reaching
profitability. Scalpers trade long or short and they typically take lots of
trades throughout the day it would not be uncommon for them to take anywhere
from 10 to 100 trades in a single day. This style requires you to have a fairly
sizeable account and you will most likely need to trade with margin. You will
need to be glued to your monitor the entire day with your eyes paying close
attention to the markets and the stocks you’re attempting to scalp. You will be
paying a boatload of commissions and one large loss can wipe out multiple wins.
You will be all cash at the end of the day and have no exposure to the markets
after the close.
Momentum traders: This strategy usually
involves press releases like earnings reports; they can be fluff pieces or
substantial news events. Typically it is a strong trending move that is
supported with high volume. Momentum traders may buy the news release and ride
the trend until it begins to lose its strength and exhibits signs of a reversal.
Some momentum traders will fade the price surge when volume dries up and a
bearish candle begins to form. Momentum traders could hold their positions for minutes
or it could be for hours. They typically work with the 5 minute 30 minute and
daily charts. Momentum traders are trying to jump on board and ride the train
to a desired profit. There are many things a momentum trader will take into
account. The news itself, the premarket or post market action, the overall
market direction, the technical indicators for support and resistance and the
overall risk reward profile. Momentum traders also need to stay glued to the
screen. Potential pitfalls of momentum trading are chasing a stock after it has
already made the bulk of its move. Closing a position too late, after
saturation has been reached and volume dries up giving all the potential gains
back. Failing to act swiftly and exit when the trade goes bad and riding the
momentum the wrong way down the tracks.
FADERS: Fading involves shorting
stocks after a parabolic move upward. It’s based on the assumption the stock
has run too far too fast. They are overbought, early buyers want to start
profit taking, and existing buyers are starting to lose confidence and getting
shook out of their position. This requires a margin account and typically short
sellers have several brokerages they trade with which allows them to be able to
find the availability of shares to borrow. This can be extremely rewarding
since stocks often take the steps up and the elevator down. Price target with
this strategy is when buyers begin stepping in with conviction it’s time to
book profits. Since shorting requires you use margin to make the trade it can
be extremely risky. Let’s say you have a stock that has a news event and it
begins to plummet. You short the stock in anticipation of it getting whacked,
the stock is halted and the news is clarified with a statement form the company
which turns out to be positive. Because of the margin element this could be a
very painful experience. Fading also requires you to be glued to the monitor
all day.
The
Pivot Trader: A pivot point is a price level of significance in technical
analysis that is used by the pivot trader as a predictive indicator of price
movement in a stock. Pivot points are associated with support and resistance
levels, a pivot point can be calculated as an average of the high, low and
close of the previous day. These can be used to determine a measured move in
the stock by subtracting or adding price differentials calculated from previous
day’s trading ranges. They typically use short time frame intraday charts 3
minute, 5 minute and 15 minute. There is R1 through R3 and S1 through S3.The R
represents resistance and the S represents support. In its simplest form, the
strategy is to enter @ R1 or S1 scale @ R2 or S2 and then exit the balance @ R3
or S3. This again requires being glued to your monitor all day.
Day trading: Day trading can be
extremely lucrative and allow you the
freedom to be your own boss. You can day trade from anywhere in the world and
if you have a disciplined strategy you can make a tremendous living.
Realistically, I suggest that you have a minimum account size of 30k. Recognize
that day trading requires you to be glued to the computer all day. If you have
a full time job, day trading is probably not the right strategy for you. It can
be extremely stressful; and it can lead to overtrading resulting in paying out
large commissions to your broker. There will also be tax ramifications from
taking short term capital gains. I recommend NOT using margin until
you have established yourself as a consistently profitable day trader with at
least one full year of experience under your belt. Pick one day trading
strategy that you are most comfortable with and try to master it. Do not try to
be a jack of all trades when you are first starting out.
One advantage
of day trading is that you will not be subject to market /stock volatility from
overnight exposure. This will give you piece of mind and allow you to sleep
without worry that you may wake up to a huge gap down in an equity or the
markets. Day trading is for technical guys that want to trade specifically from
what they read on a chart. There is no fundamental analysis; it’s based purely
on technicals, volume and price action. It will require you to learn how to
read charts and recognize specific set ups. You will need to recognize support
and resistance areas, be able to build your own scans and enjoy looking at
thousands of charts.
To be
successful, you will need to do this every single day and on the weekends. If
you think your work day ends when the market closes you are misinformed.
So
let me clarify this!
When starting out you should be working an eight hour day glued to your computer. At the end of that day you
will be running scans looking for setups for the following day. You should be
getting up at least an hour prior to the market open and looking for
opportunities for the trading day by observing the premarket action and scanning
press releases about the market and company specific events. If you are on the
west coast like I am this can be quite daunting. Your weekends are when you
should do the heavy lifting, so to speak, and run multiple scans, evaluate the
technical health of the markets and specific indexes. You should also evaluate
all of your trades from the prior week to determine where you are strong and
where you need to improve.
The
picture I am painting is not meant to scare you; it’s just a dose of reality.
You will likely work more than you would be working for someone else. You will
have to be self-motivated, and spend thousands of hours looking at charts for potential
setups. You have to be mentally prepared for that inevitable losing streak, because
it WILL happen. You will have to
accept that all the hard work that you put in each day, may not pan out and you
may miss opportunities that you were able to identify in your scans. You may
spend hundreds of hours on preparation only to end the week with negative
results.
When
deciding to become a day trader you need to have your eyes wide open and
understand completely the journey you are about to embark on. Paper trading or
using a trading simulator is advised before you actually start trading in real
time. Get a feel for your skill set and recruit a mentor or peer to help you
evaluate your strengths and weaknesses. Dedication
to continuing your education and the ability to stay motivated in the face of
defeat along with a bank roll to withstand the learning curve will be essential
if you are going to overcome the odds and your passion will be the fuel that ultimately
leads to your success.
If day trading isn't something that fits your reality then let’s take a look at a longer term
investing and trading styles.
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