This article is based on my experience from over 45 years of perfecting my stock-trading strategies and risk-control skills.
Is Day Trading Profitable?
I have over 45 years of experience buying stocks long-term, but I also experimented extensively with day-trading. I learned that it could be profitable as long as you avoid unmanageable risks. I’ll discuss crucial techniques that are necessary to stay in the game.
Short-Term Price Fluctuations
Day-trading takes advantage of short-term fluctuations. This is a risky business because prices can swing against you from the start. Professional day-traders focus on scalping small gains at a time. The profits add up with high-frequency trading.
I've learned several methods to make it work, but over 90% of my trades went against me when I first started day trading. Even when I had a profitable trade, I lost money because I was greedy and waited for more. The price fluctuations can turn a winning trade around very quickly. Greed is a terrible thing in trading, and one needs to control it.
Even worse, a profitable trade that turns against you can continue to slide down with a more considerable loss until you panic and get out at a huge loss.
That's obviously not the way to succeed! 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.
Profit Potential of Day-Trading
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. Statistically, all price fluctuations have a 50% chance of going in either direction.
So when you trade for rapid price fluctuations, you need to take any profit quickly without being greedy for more. You'll have a 50% chance of going in the wrong direction at any time. And that is true from the start when you first enter a new trade.
When I started to day-trade, I went long when the trend was up, and I went short when the trend was down. That seemed simple enough. But it didn't work. Half of my trades were consistently going in the wrong direction.
Developing Day-Trading Strategies
I experimented with using limit orders. That always worked well for my long-term investments, so I applied it to my day trades in the following way:
- When I saw an upward trend, I would go long with a limit order slightly lower than the current price. I thought I was giving myself the chance to get a better entry price because of the expected 50% price fluctuations.
- 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 thought that I would get a better price.
That process 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. That reversal continued most of the time, 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. However, that is tricky because you don't want to use a market order. Market makers will always give you the worst price since you'd pay the asking price.
It's better to place a limit order between the bid and ask. However, notice that it is not the same as what I explained earlier, where I was experimenting with placing limit orders above or below the current price. That was clearly not working.
So the best strategy is to get in at the current price with a limit order between the bid and ask, and to do that in the direction of the trend. In other words, go long when the trend is upward and go short when the trend is down.
Read More From Toughnickel
I need to tell you one last crucial thing about placing trades between the bid and asking prices. You may need to adjust that somewhat to get your trades to execute quickly before the trend reverses. So let's review this strategy further.
The Correct Way to Use Limit Orders
You now understand why you need to use a limit order to get the price you want to enter or exit. But to get in or out quickly, it's important to place those limit orders closer to the asking price on a long trade or the closer to the bid price on a short trade.
When I started using that method, my trades moved in the right direction from the start more frequently. Of course, it’s not 100% certainty, but anything better than 50% is putting the odds in your favor.
Understanding the Bid-Ask Spread
It would help to avoid stocks with a significant difference between the bid and ask prices. That's known as the spread, and if it's too big, it will increase your cost and lower your profit potential.
It's best to day trade only with stocks that have a narrow bid-ask spread. I'll explain that in more detail.
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 at which sellers are willing to sell.
Why You Need a Narrow Bid-Ask Spread
You need to day trade with small moves, taking profits quickly and not waiting for a home run. A wide bid-ask spread will cause you trouble with that strategy. For this reason, it's essential to trade only where the spread between the bid and ask is minimal.
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 a reduced tax, 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 that's not the case with futures.
How to Exit a Trade Position Successfully
I learned to be diligent about taking profits, so I get out as soon as my trades become profitable. I learned to stay in the game by taking small profits when they occur. If you can do that repeatedly, you'll have a better chance of success.
To be successful with day-trading, you need to manage risk and accept failure without letting emotions guide you. Therefore, it's crucial to understand these two points:
- Plan ahead what profit you want and take it when it occurs.
- Make a rule of how much loss you will accept and close a trade so it doesn't get worse.
- Avoid emotional trading by following a pre-determined reason for exiting a trade. 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.
If you can be strict with yourself and remember these vital points, then day trading can be an exciting experience.
- Enter and exit trades with a pre-determined plan.
- Admit when you're wrong, so you quickly get out of a bad trade.
- Keep your trades small to conserve your resources.
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.