Risks I’ve Learned to Avoid When Day Trading Stocks
I have over 40 years of stock market experience, buying and selling stocks long-term as well as day trading online.
Day trading is a risky business. I've learned a lot of tricks to make it work, from experience. 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.
My experience with day trading has enlightened me about the risks involved. I discuss crucial techniques that are necessary to understand and stay in the game.
Is Day Trading Profitable?
When I first started day trading, at the beginning over 90% of my trades went against me. I was diligent about taking profits, so when as soon as my trades turned around and became profitable, I got out.
What helped conserve my resources was that I took small profits when they occurred. If I was greedy and waited, I usually lost money. Greed is a terrible thing in trading, and one needs to control it.
I realized that this was not an entirely reliable strategy, though. I knew the day was coming that a trade would just keep going in the wrong direction and not turn around.
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. Stocks, futures, even options, can go up, or they can go down.
Moreover, they can go up or down at any time. Even if a stock went 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. Keep reminding yourself of that, because it might just save you from making a terrible mistake in the future.
I thought I knew what I was doing when I started to day trade. When the trend was up, I went long. When the trend was down, I went short.
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 almost 100% of the time then. Now I knew on some level that that wasn't a realistic expectation. But I realized I needed to figure out why my trades were consistently going in the wrong direction.
The Reason Why the Trades Went Against Me
I was placing all my trades with a limit order. When I saw an upward trend, I would go long with a limit order slightly lower than the present 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 present 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. That's not what I wanted. Because I was placing limit orders in the way I described, the trades didn't execute until the trend reversed.
And 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 the market right away and get on the ride in the direction that the market is still trending. That is tricky, however. You don’t want to use a market order because the market makers will always give you the worst price.
The Right Way to Use Limit Orders
You still need to use a limit order, 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 right from the start more frequently. It’s not a 100% certainty, but anything better than 50% is putting the odds in our favor.
What Do Bid, Spread, and Ask Mean?
<–– Spread ––>
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 Tight 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. Remember, you need to day trade with small moves. You’re in and out quick, taking small profits. A wide spread is no good in this case.
Day Trading Futures
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, and that has tax consequences, but not with futures.
Don't Let Emotions Guide You
Day trading requires an awful lot of diligence. You need to manage risk and accept failure without letting emotions guide you.
The method to avoid emotional trading is to use a mechanical rule. That is, follow a pre-determined reason for entering or exiting a trade. Never let your emotions change that plan.
One other thing. Failure to admit when you are wrong will lead to hoping that the market will turn in your favor. The market doesn't care. It's all up to you to be successful. If you can't control your emotions, then stay away from day trading.
If you can be strict with yourself and create a mechanical method of entering and exiting trades, day trading can be a worthwhile experience where you might be able to make a profit.
What’s your experience with day trading?
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