Day trading has changed significantly over the last decade. New technology has pushed many of the human decision makers from the market, and super-fast computer driven trading has all but taken. Many of the old day traders are complaining that they no longer can make money. Does this mean that day trading is dead? Not even close. But the profession has changed. In order to be profitable today, every trader must take a modern approach.
Success over time in day trading requires the ability to change. The market is always changing. The laws governing trading are changing. The technology driving trading is changing. The global marketplace is changing how the world affects and accesses the US capital markets. Why would old traders think that their tired strategies will still work today? Obviously they do not. They key to trading today is to take a modern approach by following the new rules of trading.
Rule #1 Markets Are Choppy
For most of the history of the stock market, whether you were looking at a short term move or a long term move, the market was very directional for the duration of the move. If you could understand the direction of the market, you could make money relatively stress free without being out of the money. Today, markets are choppy whether you are looking at a 10 minute period or a 10 month period. Trades are often stressful, and the market appears to reverse direction often, only to continue in its original direction further and further.
Why Markets are Fast and Choppy
The reason for this is the high percentage of volume driven by algorithms and executed by computers. For various reasons (think RSI or Fibonacci retracement) a computer will take a trade in the opposite direction as the market moves. Different trading algorithms use different indicators and different math to find potential “oversold” or “overbought” conditions, while other algorithms will pile trades into the direction of the original move. Meanwhile, the original reason for the move (either a large order or a fundamental or technical change) will continue to exert pressure for some period of time. In addition, each stock and commodity has some level of correlation with the overall market, and the market will typically exert pressure in whatever direction it is moving. The result is a lot of “noise” or competing orders in almost every trade.
Look how choppy markets are, and how quickly they change direction.
To combat this traders need to understand the reason a stock is moving in a particular direction and not be tricked out of good trades. Expect most trades to make it tough on the trader to hold, rather than moving in a straight direction. The market moves fast, and trading is not for the faint of heart. The best way to trade is to set your stop loss automatically when you take your trade, and don’t get tricked out of the trade.
Rule #2 Risk Management is Key
Any effective trader has always practiced risk management, but now more than ever this is crucial to separating traders who make money from traders who lose. Computerized trading can move a stock during times of high volatility 10% easily in a matter of seconds. If a big fast move goes against you, especially if you are leveraged, you could lose your entire trading account.
How to Manage Risk While Trading
How do you effectively manage risk while trading? Traders implement many strategies. One of the most popular ones is what is known as a stop loss. A stop loss is a pre-determined price at which your position will automatically liquidate. As long as enough liquidity exists for your position to fully exit at this price, you are guaranteed to not lose any more money than the amount you set. You can set your stop loss at any time, but ideally you will set it before or immediately after you take your position.
Another important technique is manage the size of your trades. This is especially important to a beginner. As a general rule of thumb, it is smart to never to place a trade with more than 1/10th of your total account value. This does depend upon the type of trading that you are doing, and where you set your stop losses. Remember that you always want to plan for a worst case scenario, and you never want your trading account to be completely depleted because of one random circumstance. Stocks can go bankrupt or have surprise good news leaked at any time. Things like terrorist attacks, fat finger traders, mergers and acquisitions, or an algorithm run amok can all move a stock huge amounts in just seconds of time. Computers can read news releases and take positions and can jump on existing momentum much faster than a human. You never want a random even to prevent you from trading in the future.
New Traders Take Heed
New traders have a tendency to take positions that are way too large. The large position creates extra stress, and make them deviate from the system that they are trying to follow. In order to be profitable over time, a trader must follow their system religiously. There is simply not any room to deviate for new traders who want to keep their account balance positive when it comes to managing risk effectively.
New binary option traders especially need to be careful because when they lose, they lose 100% of their entire position value. It does not take a lot of consecutive losses before an account is decimated when position size is too large.
Rule #3 Use Modern Tools
Traders today have unprecedented access to fast trading and liquidity. Market’s are segmented into many various ECN’s (electronic communication networks) and dark pools. Traders do not need to depend upon how good or fast their floor broker is any longer. The trade off that people make in this case is the speed in which prices and liquidity now moves.
An example of a modern platform.
Traders should always use a brokerage that provides a modern platform. Traders should have sophisticated “routes” to accessing liquidity, which means that they can access both dark pools and the public liquidity on various ECN‘s. Traders should always strive to get lots of liquidity, and access it fast. This gives them the absolute best price on all of their trades.
Binary Options Offer A Great Modern Tool For Traders
Some traders have moved to new security classes, such as binary options. Binary option trading does not rely on liquidity or access to certain dark pools. Traders get a market price, and they need to be in the money when the option expires. It does not matter how large them become, they can trade any stock or commodity they want equally effectively regardless of order size. Their orders do not move the price, and they always get their orders filled.
Regardless of a traders style or platform, they must be cognizant of how markets behave today. They are fast, computer generated orders represent most of the volume, and the way in which liquidity is spread across different ECN’s and dark pools present new challenges to traders. Traders need to fight back by being smarter, understanding the markets, managing risk and using modern tools.
There is still a lot of money to be made trading stocks. The key is learning to do it systematically.