Articles about daytrading has about twice as many hits than other articles (on this website). What’s so appealing with daytrading? Is it that most people think it’s easy money? It’s not, rather the opposite. Is it the adrenaline rush? It shouldn’t. The more “boring and dull” you make daytrading, the better you should perform. Is it the dream of not working for the man and be completely independent? For a lot of people daytrading can be very isolating. Is it the dream of being “left to your own devices”? Left on your own you suddenly have to take full responsibility of your actions. For many this is very hard. Using the statistics you will most likely lose, or it will take years to get consistently profitable to make a steady living. But if you have the right mindset, you can improve dramatically.
Yes, there are a lot of positives with daytrading, but as with other endeavours it requires hard work and discipline. And let’s face it: most daytraders lose money, and very few make it worthwhile considering time, effort and risk.
There are a lot of investors and gurus warning against daytrading. In the media daytrading is often described as a casino. For some it probably is, but for the rational speculator daytrading can reap good returns. I think the naysayers completely miss the point. Daytrading is not very different than for example swingtrading for 1-30 days. The principles are the same. On the contrary, a good daytrader can make a lot of money if you find a method that exploits the law of big numbers. You have a lot of asset classes to chose from: forex, bonds, options and stocks. This website focuses on the latter, where the possibility of making money is most likely higher. Just in the US there are about 5 000 possible stocks to trade.
According to some studies I have covered on this website the huge majority will never make any money daytrading (and probably no other way either unless investing for the really long term). So you have to be careful and get a lot of experience before you risk big money. Trade as small as you possibly can for at least a year. After having daytraded for 13 years I’m still astonished I find new things which I haven’t thought of. Be humble and don’t overrate your cleverness. You might be just lucky and found a strategy in a market cycle.
I’ve had four losing months since starting, all of them in 2012. I think that’s pretty good. In this article I give suggestions as to which way to go. Of course, I am not the Deplhi Oracle, far from it, but looking back I think there are certain people who has a lot better chance of being successful than other. At the same time, certain methods will most likely give better results. I know that a lot of traders will disagree. That’s fine. There are an infinite ways to succeed. However, I have tested so many strategies (both live and on paper), and I believe there are certain things that have a better survival rate than others.
Some readers might get disappointed after reading this article. There are no answers as to when to buy and sell! If so, most likely you’re looking for the easy route and let someone else develop strategies for you. Noone can do that for you.
My best advice to make money is the following (somehow ranked in the order of importance) and based on daytrading stocks only:
1. Get experience. This is by far the most important factor. You think you are experienced after one year? Think again. You learn something new every day. I have daytraded for over thirteen years and I’m stunned that I actually made money the first couple of years, given my limited experience. Looking back, I could have made a ton of money on those strategies with a lot more experience. The longer you survive, the stronger and fitter you become. It’s like Darwins evolution theory. The strongest and most fit survive. Nassim Taleb writes about surviving books in Antifragile. He never reads books less than one year. Why? Because books that have “survived” ten years most likely will last another ten years. Books that have survived 100 years, will most likely be around the next hundred years. And you can never get experience by papertrading and/or backtesting. You have to trade real money. When real money is at stake you also discover potential new strategies/ideas. If you want to start daytrading, you have to accept this is a long term project. Give yourself at least two years of practice. Personally, I have twice in my career come to a complete halt with my strategies. Both in January 2005 and in the fall of 2011 all my strategies simply just stopped working. There was no way to make any money. This is no nice feeling, but both times I have managed to fight back. In 2005 this forced me to think “outside the box” (see tip number 2) and I returned much stronger and profitable for the next years. My best years daytrading was from 2005 until 2009. If my strategies previous 2005 hadn’t stopped working, I wouldn’t make nearly as much in the coming 4 years. The trading halt was a blessing in disguise. When one door closes, another one opens. However, I have struggled a bit more from the fall of 2011, but since July 2012 I have managed to make some decent money again. All this “comebacks” is due to two things: First off, I have gained experience and market knowledge, and that experience makes me think/create new strategies. The second is my tip number 2:
2. Think outside the box. You have to be creative. Be open, humble and flexible. Often the counterintuitive could be the best place to start/look. Look on the web for input, but never expect to find profitable strategies on the web. Keep looking for ideas to test. Ask questions. Try to find strategies that noone trades. Realize you have to develop strategies yourself. The strategies you find on the web is mainly untested and based on presumptions. Look at stocks or sectors which are not popular among daytraders. Look where there are few daytraders. The more crowded, the less likely to be any prey. There are hundred of thousands people trading SPY/ES/DAX. You compete against very bright people and against machines/software that PhDs have developed (although a PhD might be worthless in the stock market). Know who you are trading against. Know where you are in the food chain! You need to prey on weaker players. It’s a brutal marketplace and you have to prepare for the fight.
3. Try to find som structural inefficiencies in how the stock market/exchange operates. Previously I used the specialist system. The NYSE used a specialist (and still uses) a specialist to fill orders. However, that has changed due to algo trading. There is hardly any money to make this route now (as far as I can see). Instead one has to find flaws in how the algos trade. Computers are stupid, and one can pick up patterns on how the machines trades. I believe short term movements for about 1-5 minutes are more inefficient than 1-2 hours, and not to mention daily movements. Think about your own life: do you have any idea how your life will be in 5 years? Most likely not, but you do have an idea what is going to happen in the coming days. I’ll give an example: Svend Egil Larsen, a Norwegian daytrader, worked out in 2007 how the computer algorithm of Timber Hill, a unit of US-based Interactive Brokers, would respond to trades in certain illiquid stocks. The stocks would change price in a uniform way regardless of how much was bid. He found that he could bump up the price with very small trades and then sell with much larger trades for a profit. He was not the only trader who worked out this flaw, which he called “painfully obvious”. (Charges of market manipulation were brought against him and another trader, Peder Veiby, in a high-profile court case where the public came to look on the duo as heroic Robin Hood figures, beating financial houses at their own game. They were found not guilty in Norway’s Supreme Court in 2012). Meanwhile Mr. Larsen – and others – continue to beat algorithms. A few months ago he says that UBS failed to set a bottom limit on one of its trading algorithms and he picked up some stock at a discount. He estimates he made $14,000 in a few minutes. “Every few weeks an algorithm is going wrong, and there is always someone making money from it,” says Kjell Jørgensen, associate professor at BI Norwegian Business School to the Norwegian press. A perfect example of this happened on the 1st of august 2012. Knight Capital lost 440 million USD because of faulty software on US stock exchanges. Their software sold and abought stocks and drove prices both down and up in about 148 different stocks. Daytraders bought on the way down and sold on the way up. KCG’s loss was mainly absorbed by daytraders. Some private/home office daytraders made hundred thousands of dollars that day by buying from this distressed seller/buyer. Every time there is a big failure of an algorithm because of a “fat finger” or programming error, there are always some traders making a lot of money. The big advantage with finding structural inefficiencies is that you know when the strategy is done and over with. The chances of finding a strategy based on randomness and/or just a market cycle is a lot less if you know there is some kind of inefficiency. You can also trade bigger size because you should know that there is an edge.
4. Develop some automated software to get you in and out of positions. That’s more important now than before. The markets are a lot faster due to algos. This also means less decisions for you to make. The strategy are tested and done, now you just need to trade them. This goes easier with automated software.
4. Look after “abnormalities”. Usually abnormalities “revert to the mean”. Of course, sometimes they don’t but this is a numbers game. Use historical quotes to get info on a stock’s distribution pattern. Here is just a very naive and simple method (and serves just as an example): 1. Find an average price over some past period. 2. Find the average High-Low range. 3. Buy when the stock drops x times than the average High-Low range. Opposite on the short side. This is naive, but it serves as an example. Stock prices are NOT normally distributed all the time, occasionally you have the “black swan”, ie outliers that deviates a lot. They can sometimes create havoc. But again, trade small and trade many so these outliers don’t ruin the whole strategy.
5. Most daytraders trade reversion to the mean. That means they provide liquidity for sellers/buyers. The stock market offers risk-taking daytraders a different form of compensation. They can earn a premium for providig liquidity for motivated sellers. There are systematic price movements that can be exploited with countertrend strategies that buy stocks that are weak/going down. Owners of stock with an urgent need to liquidate their inventory need buyers and you as a daytrader can take the opposite side and make money on this.
6. Be careful using indicators and/or charts. Many people make money on charts, but I believe it is better to find other alternatives. The best traders I know don’t use any charts or indicators at all. They mostly trade on statistical analysis. They simply form a hypothesis and test that one using statistics/the scientific method. A lot of them trade like a market maker. They buy on the downside and sell later during the day. When you read magazines like Trader’s Magazine, there are unlimited articles explaining possible strategies with charts. Typically, they’ll conclude like this: As you can see, this is a robust strategy. All evidence are just some random charts serving their strategy. These strategies are not tested. The reader have no idea if this is really a profitable strategy. Why doesn’t the writer verify the strategy by statistical analysis? Most likely because the strategy is no good and/or it’s not testable. The more testable a strategy is, the better for you. By using numbers and testing your confidence in the strategy increases. Do your own research. Never make any decisions based on someones elses research.
7. Look at this as the law of big numbers. Try to find a strategy using statistical analysis, and make as many trades as possible. If average is just 1,5 cents per share traded, this amounts to much money if trading 100 000 shares a day. The best traders think like an insurance company. You have to calculate an edge.
8. Your mindset is just as important than trading strategies. There are many investment styles and you should find out what is appropriate for yourself. Get rid of your ego. Be flexible and adaptable. It’s not necessarily the most intelligent that survives, but the most adaptable to change. Resolve your weaknesses and build confidence in yourself. That is a lot easier when having a well defined plan. Accept that you’ll lose money in between. Controlled losses is simply the cost of business. To make money, you have to approach risk. And by taking risk, you get inevitable losses. This balance is of course very thin, and everything looks so easy in hindsight. But believe me, it’s not easy to make rational decisions when you’re in the middle of the frying pan. Trade every day without emotions.
9. Be meticulate. Look at numbers. Keep statistics. Personally, I think introverts have a lot of attributes that suit daytrading. Certainly, if you’re a sucker for risk you won’t last long as a daytrader. You’ll simply blow up. You need a plan and methodology. A bad plan is better than no plan at all.
10. Be disciplined. Develop a methodology and stick to it unless proven otherwise.
11. When times are good, trade bigger and don’t take vacation. Know when to trade, but also when not to trade. Only experience can tell you that.
12. Be humble. Be very careful when you’re full of confidence. Confidence is a good thing, but too much will make you take unnecessary risk.
13. You’re only as good as your last trade. If you made money in the past, it’s no guarantee that you will in the future. I know a guy who made millions of dollars but later lost it all. As far as I can see, he was a great trader. He most likely was not lucky. He understood the game and played it really well. But in the end he broke his own rules and started making stupid trades. He stopped waiting for good trades and instead started making shots. He was trading too much size and developed too much ego.
14. You have to be adaptive and flexible. Sooner ot later everything changes and your strategies become obsolete. The ever changing market cycles. Don’t despair if that happens. You can return even stronger if you work hard enough. No one can teach you much. You have to learn this by trial and error. There is no magic strategy.
15. Be focused. If you’re trading from home, like many do, make sure you have no distractions from wife, kids, dog, etc. Buy a nice desk, chair and computer, your best friends at the workplace.
16. There is information overload in the marketplace. Try to ignore it. Don’t read too many websites, focus on just a few which generate trading ideas. Focus on making trading as simple as possible.You have to focus on yourself and your trading, not on things which is completely out of your control.
17. It’s a good advise to listen to others, but only if you know their track record. Never trade on tips and rumors.
18. Make sure you have a financial buffer. If you are desperate to make money, surely you’ll fail. The best traders don’t focus on money, but on trading. Money is just a way of keeping score. Make sure you never force trades.
19. A lot of trading coaches and learning sites focus on the necessity of stops. I believe they are wrong, stops will take you out at the wrong time. Instead, focus on trading small and trading a lot of different strategies that should correlate less. You can never time an entry correct so ultimately stops will make you bleed to death. It goes with the same with targets. The less rules, the better strategy.