When people use the term "day trading", they mean the act of buying and selling a stock within the same day. Day traders seek to make profits by leveraging large amounts of capital to take advantage of small price movements in highly liquid stocks or indexes. Here we look at some common day trading strategies that can be used by retail traders.
Entry Strategies
Certain stocks are ideal candidates for day trading. A typical day trader looks for two things in a stock: liquidity and volatility. Liquidity allows you to enter and exit a stock at a good price (i.e. tight spreads and low slippage). Volatility is simply a measure of the expected daily price range - the range in which a day trader operates. More volatility means greater profit or loss.
One day trader favorite is Sun Microsystems (Nasdaq: SUNW). The stock is cheap ($4.38 at the time of writing), liquid (almost 50 million shares traded daily) and very volatile (as can be seen by looking at its chart). This type of stock is ideal for the retail day trader.
Once you know what kind of stocks you are looking for, you need to learn how to identify possible entry points. There are three tools you can use to do this:
- Intraday Candlestick Charts - Candles provide a raw analysis of price action.
- Level II Quotes/ECN - Level II and ECN provide a look at orders as they happen.
- Real-Time News Service - News moves stocks. This tells you when news comes out.
We will look at the intraday candlestick charts and focus on the following three factors:
- Candlestick Patterns - Engulfings and dojis
- Technical Analysis - Trendlines and triangles
- Volume - Increasing or decreasing volume
There are many candlestick setups that we can look for to find an entry point. If properly used, the doji reversal pattern (highlighted in yellow in Figure 1) is one of the most reliable ones.
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Typically, we will look for a pattern like this with several confirmations:
1. First, we look for a volume spike, which will show us whether traders are supporting the price at this level.Note that this can be either on the doji candle, or on the candles immediately following it.
2. First, we look for a volume , which will show us whether traders are supporting the price at this level. Second, we look for prior support at this price level. For example, the prior low of day (LOD) or high of day (HOD).
3. We look at the Level II situation, which will show us all the open orders and order sizes.
If we follow these three steps, we can determine whether the doji is likely to produce an actual turnaround, and we can take a position if the conditions are favorable. Typically, entry points are found using a combination of these three tools.
