There are thousands of equities to choose from andday traders can pick virtually any sort of stock they want. So the first stepin day trading is figuring out what to trade. Once one, or several, stocks orETFs have been selected, the next step is coming up with some ways to profitfrom them. Here is how to select stocks for Intraday Trading.
1) High Liquidity.Liquidstocks have big volume, whereby larger quantities can be purchased and soldwithout significantly affecting the price. Since intraday trading strategiesdepend on speed and precise timing, a lot of volume makes getting into and outof trades easier. Depth is also critical, which shows you how much liquidity astock has at various price levels above or below the current market bid andoffer.
2) Medium to High Volatility. Daytraders require price movement in order to make money. Day traders can choosestocks that tend to move a lot in dollar terms or percentage terms, as thesetwo filters will often produce different results. Stocks that tend to move 3%or more per day have consistent large intraday moves to trade. The same is truefor stocks that tend to move more than $1.50 per day.
3) Group Followers.Whilethere are those who specialize in contrarian plays, most traders look forequities that move in correlation with their sector and index group. This meansthat, when the index or the sector tick upward, the individual stock’s pricealso increases. This is important if the trader wants to be trading thestrongest or weakest stocks each day (discussed in more detail later). If atrader opts to trade the same stock every day, it is wise to focus on that onestock and there is no need to worry about whether it is correlated withanything else.However, day trading is risky and requiresknowledge, skill, and discipline. If you are looking to make a big win bybetting your money on your gut feelings, try the casino.
The Entry and Exit Strategies You mayhave picked the sweetest stock in the world, but profiting from it will rely onstrategies. Intraday strategies are as numerous as traders themselves, but bysticking to certain guidelines and looking for certain intraday tradingsignals, you are more likely to succeed.
Here are five such guidelines.
1. Trade only with the currentintraday trend.Themarket always moves in waves, and it is the trader’s job to ride those waves.During an uptrend, focus on taking long positions. During a downtrend, focus ontaking short positions. Intraday trends do not continue indefinitely, butusually one or two trades, and sometimes more, can be made before a reversaloccurs. When the dominant trend shifts, begin trading with the new trend.Isolating the trend can be the difficult part.Trendlines provide a simple and useful entry and stop-loss strategy. Thefollowing chart of the SPDR S&P 500 (SPY) shows several short-term trendsduring a typical day.
More trendlines can be drawn while trading in realtime to see the varying degrees of each trend. Drawing in more trendlines mayprovide more signals and may also provide greater insight into the changingmarket dynamics.
2. Trade strong stocks in anuptrend, weak stocks in a downtrend.To choosethe best stocks for intraday trading, most traders will find it beneficial tolook at equities or ETFs that have at least a moderate to high correlation withthe S&P 500 or Nasdaq indexes and then isolate those stocks that arerelatively weak or strong compared to the index. This creates an opportunityfor the day trader, because a strong stock may move up 2% when the index movesup 1%. There is more opportunity in the stock that moves more.
When the indexes/market futures are moving higher,traders should look to buy stocks that are moving up more aggressively than thefutures. When the futures pull back, a strong stock will not pull back as much,or may not even pull back at all. These are the stocks to trade in an uptrend,as they lead the market higher and thus provide more profit potential.When the indexes/futures are dropping, it can beprofitable to short sell stocks that drop more than the market. When thefutures move higher within the downtrend, a weak stock will not move up asmuch, or will not move up at all. Weak stocks provide greater profit potentialwhen the market is falling.
The stocks and ETFs that are stronger or weakerthan the market may change daily, although certain sectors may be relativelystrong or weak for weeks at a time.The following chart compares the SPDR S&P 500to the SPDR Select Technology Fund (XLK). The blue line, XLK, was relativelystrong compared to SPY. Both ETFs moved higher throughout the day, but becauseXLK had such large gains on rallies and slightly smaller declines on pullbacks,it was a market leader and outperformed SPY on a relative basis. If you aregoing to buy something, buy the thing that is strongest.
The same is true to short trades. Short sellersshould isolate stocks or ETFs that are relatively weak. In this way, whenprices fall, you are likely to be in stocks or ETFs that will fall the most,thus increasing the profit potential of the trade.
When entering a long position, buy after the pricemoves down toward the trendline and then moves back higher. To draw an upwardtrendline, a price low and then a higher price low is needed. The line is drawnconnecting these two points and then extended out to the right. On the chartbelow, the price bounces off the trendline a couple of times before the pricefalls through it the third time.
Short selling in a downtrend would be similar. Youshould wait until the price moves up to the downward-sloping trendline, thenwhen the stock begins to move back down, you use this as a trading signal tomake your entry.
By being patient, these two long trades provide alow-risk entry. The purchase is made close to the stop-loss level, which wouldbe placed a few cents below the trendline or the most recent price low madejust prior to entry. As mentioned previously, trends don’t continueindefinitely, so there will be losing trades. But as long as an overall profitis made, even with the losses, that is what matters. Research conducted by Proquest shows that the number of daytraders who are profitable after all associated costs is around 36%
4. Take regular profits.Daytraders have limited time to capture profits and must, therefore, spend aslittle time as possible in trades that are losing money or moving in the wrongdirection.Here are two simple guidelines that can be used totake profits when trading with trends.
- In an uptrend or long position, take profits at or slightly above the former price high in the current trend.
- In a downtrend or short position, take profits at or slightly below the former price low in the current trend.
5. When the market stalls, don’tplay.Marketsdon’t always trend. Sometimes, intraday trends reverse so often that anoverriding direction is hard to establish. If major highs and lows are notbeing made, make sure the intraday movements are large enough for the potentialreward to exceed the risk. For example, if risking $0.10 per share, the stockor ETF should be moving enough to give you at least a $0.15 to $0.20 profitusing the guidelines above.
If the price is moving in a range (not trending),switch to a range-bound trading strategy. During a range, our drawn lines willbe horizontal, not angled. The same general concepts apply though. Buy when theprice moves to the lower horizontal area, (support) and then starts movinghigher. Short sell when the price reaches the upper horizontal line,(resistance) and starts to move lower again.When buying, look to exit near the top of therange, but not right at the top. When shorting, look to exit in the lowerportion of the range, but not right at the bottom. The potential reward shouldbe greater than the risk. Place a stop-loss just below the most recent lowprior to entry on a buy signal, or just above the most recent high prior toentry on a short signal.It can be hard for many traders to alternatebetween trend trading and range trading. Therefore, many traders opt to do oneor the other. If trend trading, step aside when markets are ranging and focuson trading stocks or ETFs that tend to trend. If range trading, avoid tradingduring trends and focus on trading stocks or ETFs that tend to range.
In SummaryIdentifyingthe right stocks for Intraday trading involves isolating the current markettrend from surrounding noise and then capitalizing on that trend. Certainfeatures – liquidity, volatility and correlation – characterize the best intradaytrading stocks, but it’s also important to apply the right entry and exitstrategies. Studying trendlines and charting price waves can aid in thisendeavor. There are many ways to trade and none of them work all the time. Thatis why sometimes it is just best not play and if the conditions aren’tproviding a good environment for deploying your strategies, save your money forwhen they are.
Cory Mitchell can be contacted at Vantage Point Trading