InvestorQ : What is day trading and what are the popular strategies and risks in day trading as a strategy?
prachi Patwardhan made post

What is day trading and what are the popular strategies and risks in day trading as a strategy?

2 years ago

In India we are all familiar with the concept of intraday trading or better known as day trading. It entails buying and selling the stock on the same day or selling and buying back the stock on the same day. In day trading, the net position of the trader at the end of the day is zero. Ever since rolling settlements were introduced in India, intraday trading has taken off in a big way because that is the only one can trade on the short side in equities. Professional traders, proprietary traders and individuals are all participants in day trading. However, one needs to be wary of the risk involved. While day trading can be profitable and also appear exciting, it is risky, time-consuming, and stressful. The majority of non-professional traders who attempt to day trade are not successful over the long term. More than risk taking, it is about risk management. In fact, day trading success requires dedication, discipline, and strict money management controls.

What are more important are the techniques and strategies in day trading as they are unique from your normal trading activity or investment activity. Day traders use a variety of strategies. Most common strategies are time-compressed versions of traditional trading strategies, such as trend following, range trading, and reversals. With the advent of algo trading, trading technology has evolved to the point where some individual day traders can actually place hundreds of orders and trades per day in an attempt to capture a large number of small profits. Slicing and scalping are some of the common techniques. Let us focus on some broad day trading strategies in the Indian context.

Breakout trading

Normally, a breakout occurs when a stock has surged above a significant area of price resistance. The breakout could occur above a consolidation point or above a downtrend line. A breakout can also occur on the downside too. In that case, the instrument falls below a significant area of support, which can be either a consolidation point or below an uptrend line. Breakouts need to be ratified by volumes and that is how a decision is taken on whether the break out is reliable or not. When an upside breakout occurs, breaking resistance, it’s important to look at the level of trading volume. If the breakout occurred on a surge of volume, the odds are better that the breakout will remain intact.

The question that day traders face is whether to chase a breakout and get into the market quickly or wait for the price of the stock to retreat a bit and confirm the breakout. There are no clear answers. A number of factors can come into play in making that decision, including: the underlying fundamental catalyst for the breakout; the medium- and long-term trend direction of the instrument; the behaviour of other related markets; and the trading volume attendant to the breakout. One of the basic rules of technicals is that an area of resistance becomes the new level of support after the resistance is broken on the upside. The idea is that price will retreat, confirm the new support level, and then move higher again. The reverse applies in case of a lower break out wherein the support level now becomes the resistance. These levels are very useful for traders to decide where exactly they should put their stop losses.

Pullback trading

A pullback is all about waiting for the first retracement (pullback) down to support of either its primary uptrend line or its moving average to get into the market. For day trading purposes, a trader may identify a stock that has shown a good deal of upside strength in past several trading days. The idea is then to jump into the market when stock retreats to a support level. This is can be applied to stocks and to indices. In pullback trading it is critical to ensure that a clearly defined trend is in place else you may enter the trade too early. A clearly defined uptrend could imply that you are looking for at least two higher highs and two higher lows in daily trading charts. A clearly defined downtrend would be two lower lows and two lower highs. A key point to remember here is the basic rule of trend trading: the longer a trend has been intact, the more likely the established trend will continue in the same direction. If a stock has been steadily trending higher for several weeks, the odds are much greater that it will continue to trend higher as opposed to a market that has been trending higher for only a few days. That is when momentum is in its favour.

While the above two strategies are the most common among day traders, they normally use one of the modified versions of sub versions of the above too. There some risks that you need to be conscious about. For example, many day traders trade on margin that is provided to them by their brokerage firm. Margin is essentially a loan to the investor, and it is the decision of the broker whether to provide margin to any individual investor. This creates a leverage risk when day trading because your actual trade is normally a multiple of your paying capacity. Margin trading entails greater risk including loss and incurrence of margin interest debt in some cases. In short, it puts you at risk of insolvency without your knowing about it in most cases. One more thing to remember is that you are competing against professional traders. Hence it is important that you educate yourself, find a method that you’re comfortable with and can implement consistently. Above all, day trading is all about discipline. This includes discipline in stop losses, profit targets, capital protection etc. That is the hallmark of a good trader.