THE market volatility we have experienced over the past 18 months or so has encouraged private investors to try their hand at the fast-moving, risk-riddled strategy of day trading because of the large daily moves in stocks combined with overnight uncertainty. And opportunistic spread betters have been all too keen to jump on the back of surging or plummeting shares, hoping to make a fortune that they (rightly) feel is no longer available to them in the troubled buy-to-let market.
But while the rewards of day trading are potentially huge, it takes a great amount of skill and hard work to capitalise on market moves and plenty of wannabe day traders have got themselves burned while chasing profits. A lot of traders will stick to indices or foreign exchange, but individual stocks also have day trading potential, says Josh DiPietro.
In his new book The Truth About Day Trading Stocks: A Cautionary Tale About Hard Challenges And What It Takes To Succeed, due to be published in the UK next month, DiPietro gives an insight in to what it takes to become a day trader.
And he should know: he has been day trading stocks for 10 years and also runs his own website www.daytraderjosh.com. He gives five key criteria on which day traders should be choosing their stocks to watch. These five rules help to filter out the high-risk stocks and those that don’t perform well when they are day-traded.
Firstly, DiPietro says that your stock should have had an average daily volume of a million shares or more over the past three months.
He says: “Low volume means low interest and you want to be trading a stock that has high interest. Liquidity is an indicator of trading interest and the more liquidity there is, the less chance there is that marker makers will manipulate your trading activity.”
In volatile penny stocks that have low volumes, market makers can dictate the direction of the stock very easily and will be able to counter your trades, using the price swings to their advantage.
Secondly, he says that you should also choose stocks that are trading between $10 and $100 (or £6-60) – although with so many share prices decimated during the financial crisis, you may well want to lower the minimum limit. His rationale is that a stock price above $10 usually indicates a company’s good health. But too highly priced is not good – these stocks tend to be very volatile and have more chance of retracing.
Since day trading depends on market volatility, you also need to choose stocks that have sufficient average intraday price swings, says DiPietro. This requires spending time studying the intraday chart patterns and determining what the the price swings mean, as well as whether it is possible to identify key support and resistance levels. As he succinctly sums up: “Stay away from stocks that show intraday patterns that resemble a heart patient flatlining. Keep in mind that you can’t make any money if the stock doesn’t bounce intraday.”
Fourthly, while biotech stocks and pharmaceutical companies can see sharp moves upwards on the back of approval by the health regulators, you can easily be caught out by their decision. Biotech companies have to acquire the regulator’s consent in a number of trials before being able to sell their product. Any setback can see the stocks price plummet immediately following the announcement, which is dire for day traders. Instead you want to be selecting stocks that sell stable consumer products such as supermarkets, drinks manufacturers and technology stocks.
Finally, DiPietro says you should beware of stocks that are directly affected by news headlines. While the volatility resulting from the news stories can be substantial, he warns that “you are gambling, not day trading, if you think you can predict how the stock price will react to the news”. Too much news about a stock can create uncertainty, which in turn will lead to choppy volatility rather than a sharp surges and falls that are the day trader’s friends.
Day trading requires hard work, enduring patience and plenty of discipline to stick to your trading plan, all of which are discussed in other parts of DiPietro’s book. But by selecting the right stocks to watch, you are putting yourself at an immediate advantage and reducing your chances of getting burned.
The Truth About Day Trading Stocks: A Cautionary Tale About Hard Challenges And What It Takes To Succeed is written by Josh DiPietro.The book is scheduled to be published in the UK in August by Wiley. RRP: £42.50.