Glenn Stok writes about investment and risk-control strategies he perfected in 45 years trading stocks, options, and futures contracts.
I have over 45 years of stock market experience, usually buying stocks long-term. But I also experimented extensively with day trading. I’ll explain what happens when you day trade stocks the right and wrong way. And I'll describe the techniques you need to understand to stay in the game.
Is Day Trading Profitable?
Day trading is a risky business. I've learned a lot of tricks from experience to make it work. Successful professional day traders focus on scalping small gains at a time. The profits add up with high-frequency trading. However, this is a very emotionally stressful business.
When I first started day trading, over 90% of my trades went against me. Even when I had a profitable trade, I usually lost money if I was greedy and waited for more. Greed is a terrible thing in trading, and one needs to control it.
A profitable trade can turn against you in seconds and continue to slide down with a more considerable loss until you panic and get out of the trade at a huge loss. That's obviously not the way to succeed, but it happens to most people who try day trading without knowing what they are doing.
I realized that this was not an entirely reliable strategy. I knew the day was coming that a trade would keep going in the wrong direction and not back in my favor.
I needed to figure out why it seemed that most of my trades started in the wrong direction. You would think that there would be a 50-50 chance of profit or loss. Stocks, futures, even options, can go up, or they can go down.
Even if a stock goes sky-high and you think it will give some of that back, it still has a 50% chance of going higher. That’s what statistics show. So keep reminding yourself of that because it might just save you from making a terrible mistake in the future.
Here's What Happened When I Began Day Trading
I thought I knew what I was doing when I started to day trade. When the direction of the trend was up, I went long. When the trend was down, I went short. That seemed simple enough. But it didn't work.
Giving it some consideration and knowing that I was wrong most of the time, I thought that I just needed to put my trades in the opposite direction from what I intended to do. I figured I’d be successful most of the time then.
That was silly, and it failed most of the time just as well. I knew that that wasn't a realistic expectation on some conscious level, but I realized I needed to figure out why my trades were consistently going in the wrong direction.
The Reason Why My Trades Went Against Me
When I first started day trading, I used limit orders that didn't work. When I saw an upward trend, I would go long with a limit order slightly lower than the current price. I thought that I was giving myself the chance to get a better entry price because everything fluctuates anyway.
I also did the same thing in reverse. When I saw a downward trend, I entered a limit order going short at a slightly higher entry than the current price. Again, I was thinking that I was getting a better price.
That didn't work because I was forcing my trades to wait for a reversal. Since I was placing limit orders waiting for a pull-back, the trades didn't execute until the trend reversed. Most of the time, that reversal continued, going in the opposite direction from what I wanted.
The ideal solution would seem to be to get into a trade right away and stay with it while the stock is trending in the expected direction. That is tricky, however, because you don’t want to use a market order. Market makers will always give you the worst price.
The Correct Way to Use Limit Orders
You need to use a limit order to get the price at which you want to enter or exit. But place those limit orders for the asking price on a long trade or the bid price on a short trade. Those trades will execute immediately and without any surprises.
Once I started placing trades at the bid and ask, my trades moved in the right direction from the start more frequently. Of course, it’s not a 100% certainty, but anything better than 50% is putting the odds in your favor.
It would help if you avoided stocks that have a huge difference between the bid and ask prices. That spread, as it's called, will increase your cost and lower your profit on the closing side of the trade. It's best to day trade only with stocks that have a narrow bid-ask spread. I'll explain that in more detail next.
What Do Bid, Spread, and Ask Mean?
|Bid||<–– Spread ––>||Ask|
The price buyers are willing to pay.
The difference between the bid and the asking prices.
The price sellers are willing to sell at.
Why You Need a Narrow Bid-Ask Spread
The trade still has only a 50% chance of going one way or the other. However, the trend helps a little as long as it doesn’t turn on you before you get out.
For this reason, it's essential to trade only where the spread between the bid and ask is minimal. Otherwise, you may not get a chance to close the trade at a profit.
You need to day trade with small moves, taking profits quickly and not waiting for a home run. A wide bid-ask spread will only cause you trouble with that strategy.
I learned to be diligent about taking profits, so I got out as soon as my trades became profitable. I learned stay in the game by taking small profits when they occurred. If you can do that repeatedly, you'll have a better chance of success.
Day Trading With Futures Has Advantages
Besides stocks, I like trading the Mini S&P 500 Futures. It’s heavily traded and therefore has a small bid-ask spread. So if you need to get out soon, you don't get hurt by a sizable spread.
Other advantages of Mini S&P 500 Futures:
- IRS section 1256 allows applying 60% of the gains as long-term for tax purposes, even if held for less than a day.
- There are no day trading limits with futures. The IRS may consider you a day trader if you trade stocks more than three times a day, which has tax consequences, but not with futures.
Trade Mechanically So Emotions Don't Guide You
To be successful with day trading, you need to manage risk and accept failure without letting emotions guide you. It's crucial to understand these two points:
- The method to avoid emotional trading is to follow a pre-determined reason for entering or exiting a trade. Do that mechanically, and never let your emotions change that plan.
- Failure to admit when you are wrong will lead you to hope that the market will turn in your favor. If you can't control your emotions, then stay away from day trading.
To remind you what I discussed:
- Use a mechanical method of entering and exiting trades.
- Admit when you're wrong, so you get out of a bad trade quickly.
- Keep your trades small to conserve your resources.
If you can be strict with yourself and remember these vital points, then day trading can be an exciting experience where you might make a profit.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2016 Glenn Stok
Glenn Stok (author) from Long Island, NY on November 21, 2016:
Nell Rose - If you're new to trading it would be helpful if you know someone who does this actively so you can work and learn side by side. There are a lot of things to understand in order to make this a success. I wrote a few hubs on various trading strategies. As you said, Nell, you never know. It's always enjoyable learning new things.
Nell Rose from England on November 21, 2016:
This is interesting, and not something I had thought would get my attention, but I may just go and take a look to see what it entails! you never know...lol!
Amy from East Coast on October 31, 2016:
Great article. I have had some positive experiences with day trading. Usually I go for popular strong companies. Very informative article. Lots of luck!
Glenn Stok (author) from Long Island, NY on October 30, 2016:
FlourishAnyway - Sounds like you've got it all worked out for diligent investing.
FlourishAnyway from USA on October 30, 2016:
I'm more of a short and long term investor but I manage to keep emotions completely in check and try not to over analyze my stock picks. Some people go way down deep into th weeds but I look at a couple of key numbers, and it has worked very well overall as an additional income generator.