The long day-trading drought has ended as the U.S. stock market’s intraday volatility has soared in the past several weeks.
For example, on Monday the S&P 500 SPX, -2.23% moved in a 79-point intraday range between 2,554 and 2,633. Although no one can predict how long this volatile stretch will continue, as a strategy, day trading has been working. Day traders’ big advantage over buy-and-hold investors is that they don’t care if the market goes up (it’s possible there will be one final blow-off top), or down (almost every rally has recently failed and the S&P 500 is below its key 200-day moving average).
As long as there is volatility, day traders may generate profits. Nevertheless, just because day trading strategies are working right now doesn’t mean you should quit your job or even use this strategy. That’s what many traders did in the 1990s, and it didn’t end well.
For those interested in day trading, consider the following:
1. Start small: The No. 1 rule is to start small. Whether you are day trading stocks, options, or exchange-traded funds, if you are a beginner, start with no more than 100 shares of stock or one or two options contracts. This way you can make every potential mistake using as little money as possible. It can take years to learn how to be a consistent trader. Your tuition is the money you will likely lose as you learn how to manage risk. Remember, most day traders lose money at first, which is why you want to keep losses small.
2. Trade for real, not practice: I no longer believe in using practice accounts. Practice accounts are not realistic if you want to feel the pain of loss and the thrill of making real profits. By trading small, (say $1,000), you will experience real emotions without severe financial damage when you’re wrong.
3. Be selective: If you have less than $25,000 in your account, you are limited to making only three day trades during each five business day period in a margin account (contact your brokerage for specific rules). Once you make that fourth round-trip day trade, you will be designated as a “pattern day trader” and must put $25,000 in the account to continue trading.
This is a good rule. Beginners will learn to make more selective trades, rather than buying and selling dozens of times a day. If you’re that good of a trader, you will eventually be able to build your account past the $25,000 threshold even if you’re starting with $5,000.
4. Don’t be overconfident: The biggest danger to most day traders is overconfidence. Often, day traders make 5%, 10%, 20% on their money in one day. So instead of trading small, many traders bet big on the next trade, perhaps using margin (not recommended for most traders) — and instead of making the big score, they blow up their account. Never trade more than what you can afford to lose. Once you cross over from disciplined trading to gambling, you will likely lose money, perhaps all of it.
5. Be emotionless: The best traders are often the most unemotional. When you think you are a genius (as many long-term investors thought a month ago), you could give back your profits. Here’s a hint: After I make a huge profit, I stop trading for the rest of the day, and perhaps even the next few days. If you feel giddy or too eager to make a trade, that’s a clue to stop trading.
6. Keep a trading diary: If you want to be an educated trader, keep a trading diary. In this diary you will write all of your mistakes and what you learned. By writing it on paper, you will eventually find strategies that work for you, indicators that will keep you on the right side of the market, and rules that will help you cut losses when wrong and increase gains when right.
7. Concentrate: Beginner day traders underestimate the concentration needed when day trading. Although you don’t have to sit in front of the computer and trade all day, when you do have an open position, you must watch it like a hawk or you may lose money. Speaking from experience, in the past I had large open positions, went to lunch, and when I returned I had lost thousands of dollars. If you cannot watch your open positions closely, don’t trade.
8. Trade only one or two stocks: You do not need to trade or even watch dozens of stocks every day. If you are starting out, focus on trading only one or two stocks or indexes. Popular index-tracking ETFs are good choices, such as SPDR S&P 500 ETF Trust SPY, -2.16% , SPDR Dow Jones Industrial Average ETF Trust DIA, -2.17% , iShares Russell 2000 ETF IWM, -2.44% , or PowerShares QQQ Trust QQQ, -2.89% . Or you can choose one or two stocks and learn their trading personalities. The more stocks you trade, the more confusing it gets when the market turns on you.
9. Be content with small profits: Another huge problem for day traders is greed. Instead of being satisfied with a $100 or $200 daily gain, they fret over the money they could have made. At first, your goal is to be a disciplined and consistent trader. Aim for hitting singles, not home runs. Learn to book profits quickly, almost always before the end of the day, if not before noon.
10. Don’t trade every day: You do not have to trade every day. On the days when intraday volatility is low, day trading strategies may not work. Eventually, after the next correction or bear market is over, volatility will get crushed once again. That’s when you may have to reduce day trading strategies and primarily use buy and hold. Meanwhile, strike while the iron is hot, because day-trading’s day in the sun won’t last forever.
Michael Sincere ( michaelsincere.com ) is the author of “Understanding Options 2E” and “Start Day Trading Now.”