How to Start Day Trading for Beginners 3/7/2014

How to Start Day Trading for Beginners

Day trading can be defined as buying and selling of financial instruments, such that all

positions are closed before the market close for the trading day. Traders who participate in

day trading are called active traders or day traders.

Some of the more commonly day-traded financial instruments are stocks, options,

currencies, and a host of futures contracts such as equity index futures, interest rate

futures, and commodity futures.

Day trading is a risky business. One can make a lot of money if done in a disciplined way.

On the other hand it can ruin your financial status if done recklessly.

Many wise men have mentioned that day trading is not for investors new to capital

market. While this is true, contrary you can never understand the underlying mystery of

day trading if you do not experience it. You may read dozens of good books on day

trading available at your finger tips, yet still wonder why do markets behave the way they

do, why do stock prices all of a sudden gather momentum in one direction, when to buy a

stock and when to sell, and how do some people always make money while others lose.

In this article I would tell how you could start your journey as a day trader even if you are

a beginner in the stock market. Making money through day trading is not rocket science

and could be achieved through knowledge and discipline. Traders like Paul Traders,

George Soros, Rakesh Jhunjhunwala and Alexander Elder; all made huge fortunes through

day trading.

1. Account Setting: - The first thing to do is to open a trading account with a reliable

broker in the market. You can choose a broker who can provide a competitive

trading platform, charges reasonable brokerage fee from you and is trustworthy.

Brokerage fee is charged as a percentage on the share price on both buying and

selling. Be alert on the brokerage charged as that’s the way brokers make money.

Compare it with the market and try to minimize it as much as possible. Always

calculate your profit and loss after taking brokerage into consideration. Apart from

these you need a computer with a fast processor and a high speed internet

connection. Stock prices change very fast and if your system is slow, you may end

up buying or selling your shares at a price higher or lower than you expect.

2. Buy Small: - The very first rule of Day trading is to buy small quantity of shares.

We call this volume of shares purchased. In margin trading your broker will give

super multiple trading facilities on your account, which may allow you buy at

credit 10-12 times more than your cash available in the account. For example if you

have $1,000 in your account, you can buy shares worth of Rs. $10,000 provided

you sell them before the end of the day. This is a deadly trap. This is how brokers

make money. This lures you to buy stock more than your capacity and if the market

does not move as predicted you may suffer huge loss. In extreme cases of market

crash you may lose majority of the borrowed money and may have to liquidate

your assets to pay off the broker. Stay away from it.

If your purchased quantity is small, then in case the market moves in opposite

direction, the loss suffered by you would be small. For example you purchase 500

quantity of Axis Bank each @ Rs, 1200. Axis bank is high volatile stock and

gathers momentum very quickly. You anticipate that the market will go up and you

intend to sell your shares @ a price of Rs.1220, incurring a profit of 1.75%, which

is a good target for intraday. But unfortunately there was some negative news and

the market started to fall. Within few minutes Axis Bank share price fell to Rs.1175

from Rs.1200. Your loss is 25 X 500=Rs.12, 500. Had you purchased only 100

quantities instead of 500, your loss would have been only Rs.2500 which is far

better than losing Rs.12, 500. Volume is the prime factor that determines your

overall profit and loss. So, then why people buy huge volumes. The answer to this

is “greed”. Speculators are impractically optimist and they predict that the market

will always move in their desired direction, and high volume will give them high

profit. Their greed compels them to think in that way, until it is too late.

Whether you have the money or you buy on margin, trading small quantity of

shares will always keep you on a safer side and less attached emotionally especially

if you are a beginner.

3. Stop Loss is a Must: - This is a golden rule. If you wish not to lose away your

hard earned money in the stock market, you cannot afford to ignore this rule. Stop

loss is a must in all your trade. Well, I repeat again, STOP LOSS IS A MUST!

Many investors struggle with the task of determining where to set their stop loss

levels. Investors don’t want to set their stop loss levels too far away and lose too

much money if the stock moves in the wrong direction. On the other hand,

investors don’t want to set their stop loss levels too close and lose money by being

taken out of their trades too early.

Years of research have shown that putting a stop loss at 0.5% price below or above the

traded price is a good method to practice. This is not a hard and fast rule, yet an effective

rule in most cases. For example you buy 100 ICICI bank shares @ Rs.1050 per share. As

per the above rule, your stop loss would be at Rs.1050-(0.5% of Rs.1050) or Rs.1044.75.

On the other hand if you short sell ICICI bank in a bear market your stop loss would be

Rs.1050+ (0.5% of Rs.1050) or R.1055.25. If the stock price moves in the opposite

direction than expected, as soon as the price reaches the trigger price, bang! Your order is

executed.

Stop loss could also be put on the support and resistance level. To use this method, you

need to be able to identify the stock’s most recent level of support and resistance. Some

analysts would advice to keep little buffer while putting your stop loss on support and

resistance level. The reason is you want to give the stock a little bit of wiggle room before

deciding to exit your trade. Stock prices usually tend to revert back from their support and

resistance level, so it is important to give the stock some space to come down and bounce

back up off, of its support level before pulling the trigger. For example the nearest support

level for ICICI bank share is 1045, and the graph shows that the price reverts back from

here three out of four times. So if you put a stop loss at this price your order would get

executed here, but may be the price again moves upward, leaving you with repentance and

frustration.

Stop loss can also be put using Moving Average Method. To use this method, you need to

apply a moving average to your stock chart. Typically, you will want to use a longer -term

moving average as opposed to a shorter-term moving average to avoid setting your stop

loss too close to the price of the stock and getting whipped out of your trade too early. Just

as in the example above using the support method, you should set your stop loss just

below the moving average to give the stock a little room to breathe.

As I told earlier there is no hard and fast rule of putting a stop loss. The above methods are

only popular and reliable methods. At the end, the trader has to decide at which price he or

she wants to put a stop loss. The price would be based on the maximum loss he could

afford to lose on a single trade.

4. Never try to catch a falling knife: - One of the common investor mistakes that

occur quite often is trying to catch the bottom in a stock, or trying to catch a falling

knife, as some might say. This means when you see a stock price is falling and

technical or fundamental analysis says that the price will fall further, and there is

meager chance of the stock price to rebound back, then a trader should not try to

hold onto his position, with an anticipation believing a rebound might occur. At

this stage it is very critical to control your emotions (which I would discuss in the

next point) and get out of the trade at a small loss. That is why it is so important to

strictly maintain your stop loss. A wise investor would ride profit and stop loss.

Unfortunately, many investors actually do the opposite. They ride loss and stop

profit. When they start earning profit they exit the position too early thinking they

had enough or they might lose whatever they have earned. On the other hand when

they suffer loss, they hesitate to exit the position thinking that the market may

bounce back.

5. Control your Emotions: - This is another golden rule of trading. Well, it may not

sound like one, but yes it is. In fact I think it is the most important rule of trading

and actually has the capability to determine your trading fate. Humans are bound

by emotions, but there is no place for them in stock trading. The stock market does

not know who is trading at the other end. It does not matter to him whether the

trader is a Harvard Graduate or an undergraduate, a millionaire or a pauper. It does

not care about your mood whether you are upset or happy, how busy you are,

whether you are the President of the country or just a common man, what is your

social status, nothing. All it understands is the market and the stock price.

It is not unusual for a trader to get emotional while trading. Every investor has their

set of favorite stocks which they trade repeatedly, not because of any technical

reason but due to emotional attachment. May be that security had given good

returns in past, but that does not necessarily mean it will continue to do the same

every day. There may be times when that particular security is going through

turmoility, with unpredictable trends and may not be the best one to trade, yet

traders keep on trading them out of emotions suffering heavy losses. Every time

they suffer a loss, they re-trade the same again, believing that the next time he

would surely earn profit, because this particular security had given him good

returns in past. How sad!

There are four psychological states of emotions that drive most individual decision

making in any market in the world. They are greed, fear, hope and regret.

i. Greed: - Greed is commonly defined as an excessive desire for anything

usually money and wealth. In trading terminology it can be defined as a

desire to achieve immediate and unrealistic profit. When greed sets in, all a

trader can focus on is how much money he has made and how much more

he could make by staying in the trade. They do not close the position, even

if the stock starts moving in the wrong direction. For example, a trader

purchased 100 shares of Infosys @ a price of Rs.3500 each share. After that

Infosys share price reached 3600, and then started reverting back. A wise

trader would sell his position after a certain point and would keep the rest

of the profit; while a greedy trader would hold on to his position thinking

the share price would move up again, even if the technical analysis shows

evidences against it. At the end he would lose most or all of his profit and

may even incur loss, due to his lack of rational judgment. Same thing can

happen in case of stop loss. Many traders do no strictly maintain their stop

loss. They do not want to give up the money they already lost and hold onto

their position resulting to further loss. I would like to go back to the ICIC

example where the trader purchased 100 quantities @ Rs.1050 each and put

a stop loss of 1044. If he sells his shares @ Rs.1044 he would lose Rs.600

plus brokerage but assume he is greedy and do not want to lose any money.

As the price started to decline he removed his stop loss and waited for the

price to go up. Unfortunately the price went down till Rs.1030 resulting to

a loss of Rs.2000 + brokerage. When you know you cannot avoid loss, the

best thing you can do is to minimize that loss.

ii. Fear: - Fear is defined as a distressing emotion that is caused by a feeling

of impending danger, which results in a survival response. This holds true

regardless of whether the threat is real or imagined.

Fear is one of the most dominant emotions in stock trading. When traders

become afraid, they will sell a position regardless of the price. Fear leads to

panic, and panic leads to poor decision making. People have been known to

commit suicide out of panic during market crash. Fear is more dangerous

than greed, because you will not hear any one jumping off of a building

because of greed. When people panic they sell off their position. When a

group of traders, starts selling their shares, it starts bringing down the price

followed by a dominos effect. Everyone else follows the trend and sells off

their position resulting in market crash. However it is advisable when a

market is in a state of panic individual trader should never try to rationalize

or come up with excuses why they should not get out of their

positions. During times of fear and panic, it is best to go to cash. Listening

to the news, the government, stock experts, or other trader’s opinions is a

waste of time. At the end of the day the market is right and it always wins. If

the market is in a state of panic, it is best to not fight the trend. An

individual trader does not have enough money to lift the market. When

institutional traders (banks, mutual funds, and hedge funds) decide to dump

their positions, the market will fall. It took the Dow Jones Industrial

Average from 1983 until 2007 (24 years) to rally from 1,000 to 14,200, but

it only took two years to lose half of its value (2007-2009).

That’s a dramatic example of the power of fear.

Fear can work against a trader when they don’t enter a quality setup because

they have had a series of losing trades. Just because a trader has lost money

in the previous trades does not mean he should be fearful of entering the

next trade.

Truly understanding the power of fear is one of the key pieces of the puzzle

to improving your online trading education.

iii. Hope: - Hope is a feeling of expectation and desire for a certain thing to

happen, not backed by any logical explanation. It’s an individual’s desire to

want or wish for a desired event to happen

Hope is a deceiving and most treacherous emotion when it comes to trading.

Hope is what keeps a trader in a losing trade after it has hit the stop. Greed

and hope are what often prevent a trader from taking profits on a winning

trade. When a stock is going up, traders will often remain in the trade in the

“hope” of recouping past losses. As I mentioned before the market does not

care who you are. So any decision based on “hope” and not backed by

technical and fundamental analysis is sure going to be doomed. A trader

may get lucky once or twice, but in the long run all of his trading funds, are

sure to perish.

iv. Regret: - Regret is defined as a feeling of sadness or disappointment over

something that has happened or been done, especially when it involves a

loss or a missed opportunity. It is natural for a stock trader to regret taking

on a losing trade or missing a winning trade. But what is important as a

trader is not to hyper focus on losing trades or missed opportunities , but to

simply evaluate what went wrong and move forward. It's no use crying over

spilt milk.

6. Be Dynamic:- As I mentioned before , stock market is very dynamic. They change

like flash of lightning. As a trader you have to match its tempo in order to be

successful. You ought to be alert and vigilant all the time. Keep yourself updated

with the market, listen to the news, read newspapers, blogs, and most important of

all, constantly monitor on how the market is reacting to all of these. If a bad news

hits the market, you need to sell off your position quickly before it’s too late.

Contrary when the market is in boom, you need to take a position before the price

reaches its peak. You really need to react faster to beat the other traders. Remember

stock market is a zero sum game. When a trader loses money, some other trader

gains that money and vice versa. It follows the jungle rule where you either eat or

get eaten.

7. Diversification of your Portfolio: - We often hear the phrase “Don’t put all your

eggs in one basket.” Putting all eggs in one basket means to put all your resources

into one place and getting dependent on it. That’s not a very wise thing to do. If the

basket breaks then you lose all your eggs. It’s very important to diversify your

portfolio. Never put all your money into one company not even in one industry.

When the industry is down, even the best stock can perform worse. Also, you

should not restrict yourself to only one kind of investment, for example only in

equity, or only in fixed securities. Portfolio of different kinds of investments will,

on average, yield higher returns and pose a lower risk than any individual

investment found within the portfolio. Your portfolio should be spread among

many different investment vehicles such as cash, stocks, bonds, mutual funds, and

perhaps even some real estate. Picking different investments with different rates of

return will ensure that large gains offset losses in other areas.

This diversification depends on the investor’s risk appetite. If the investor is risk

averse he should invest majority of his funds (70%) into fixed securities and lesser

into mutual funds (15%-20%) and even lesser into equities (10%). An aggressive

investor will allocate major portion of his funds (70%-75%) into equities, 15% on

fixed income and 10% on commodities. At the end of the day, investors should

consider all of these portfolios and decide on the right allocation.

8. Do not trade everyday: - Last, but not the least it is advisable to not trade every

day, unless you are a professional trader. Sometimes the best trade is no trade at all.

If you are a beginner, it’s a sincere advice to follow this rule. The reason behind, if

you are a beginner, you are bound to make more mistakes than someone who is

experienced. Also, every day trading can get you easily addicted to the stock

market, and we all know when we get addicted we lose our capability to rationally.

Addiction paralyzes our logical thinking and trading decisions are taken out of

emotions, which results to disaster. Also, every day the market trend may not be

predictable. Market may move in a very narrow range, and trading becomes risky.

If you only trade during good times, like when the market trend is clear and

understandable, your chances of making profit increases dramatically.

The above mentioned facts are not exhaustive but definitely a good start point for

day trading. Obviously in addition to the above mentioned points a trader also need

to do fundamental and technical analysis of stock, for success in the stock market,

but analysis alone is not enough. Its only when analysis combines with discipline

and golden rules can produce invincible results.