HamFon's daytrading thoughts and notes

These notes and thoughts are random information that I've learned as I've progressed from a complete newbie daytrader (with absolutely no clue other than "sounds like a cool job!") through my market and daytrading education. This education is a continuous process - there is always more to learn.

Yes

Definitely NOT! Daytrading is a very difficult thing to do well. There is much to learn, there are mechanical processes to understand and follow, there are money management skills and, perhaps most of all, there are psychological and emotional barriers to deal with. Here is a checklist of what you need to do to become a successful daytrader:

• Learn how to place, cancel, and change Limit orders efficiently
• Get to be very familiar with your execution platform, so that you can act when necessary
• Understand and take account of commissions
• Attempt to manage your trade entry to be in the direction of price movement (either short or long)
• Learn to manage your trade exit to get you out with minimum losses if the trade goes against you
• Learn to manage your trade exit to capture most of a trend, without stopping out prematurely on retraces, but not leaving too much money on the table with reversals
• Be able to sit at your computer all day and concentrate - this isn't Monopoly money!
• Assemble a set of tools to help you identify opportunities, and then be able to use these tools effectively
• Overcome the emotional issues involving losses (which will happen). Become a machine - block the Fear and the Greed emotions.
• You are TOTALLY responsible - you get out what you put into it. You can't blame other people for your failure to make a profit. You need to be able to work with the market, not against it. Can you handle that degree of responsibility?
• You need to be able and willing to buy stocks, or sell stocks short, depending on the conditions - let the market and stock tell you which way to play it, and leave your preconceived notions elsewhere
• Resist the urge to trade - wait until you find a good trade setup that offers higher rewards for risk
• Manage your money, trade size, and risk to give a good reward-to-risk ratio
• You'll need some money that you can afford to lose. Don't use your mortgage, food, and clothes money. When you start, you must expect to not be successful immediately. Expect to lose money during your "training" period - treat it as tuition for career training.
• You need to be able to devote substantial time to your training - particularly if you are looking at this as a full-time career - your main source of disposable income. You need to devote time before the markets open for research; you need to devote time for reading, learning, and training; you need to devote a long duration of time to "ramping up" to the point where you can consistently make a profit. How long? Expect 6 months minimum - and possibly substantially longer, maybe several years.
• Watch Trading Places (the movie) for inspiration, while sampling a Guiness. This may be repeated as often as necessary - but NOT during "working hours". ;)

If you fail to do any of these, your career as a daytrader will probably not be successful. Depending on which article or book you read, 70 to 95 percent of the people who attempt to be daytraders will fail within the first year. Failure means that either they decide to not do it, they find they can not perform the job and make a profit, or they run out of money.

You need to be able to trade stocks in at least 100-share lots, and possibly several stocks at one time. For example, with a $50 stock, you need $5,000 for each 100 share lot, $25,000 for each 500 share lot, etc. You also do not want to risk a large portion of your account on any single trade. My personal opinion is that your account should start with at least $50,000 to give you the flexibility to deal with multiple trades at one time. This also gives you a bit of a cushion in case several trades go against you. During your "tuition" period, when you are consistently losing money, you should be placing minimum orders - lots of 100 shares. Remember to factor in the commission costs - a $15 commission each way for 100 shares means that you need to make $30 (which means your stock price must go in the direction of your trade by 30 cents) just to break even!. I use TradeStation - and highly recommend it - commission for 100 shares is $2.40 round trip - and it's easy to calculate how much the stock must go in your favor to break even. For taxing purposes, be sure to take this initial capital and open a new brokerage account which is for daytrading ONLY. Keep any 401(k), IRA, or investment accounts separate.

What is your goal? "Get rich" isn't a realistic goal - at least not when you are starting. Let's make up some reasonable numbers to present an idea of what you are capable of. Let's say you want to have pre-tax income of $100,000 per year (be sure to make quarterly IRS estimated payments to avoid a big penalty when you file your taxes). Of the 365 days in a year, about 104 (52 weeks of Saturday and Sunday) are weekends, and several more (Christmas, Independence Day, etc.) are days when the market is closed - holidays. A nice estimate for usable daytrader working days is about 250. So, if you want $100,000 per year, you need to average $100,000/250 = $400 per day. Depending on your account size, the number of trades you place, the size of your trades, and your average profit per trade, this is certainly attainable.

Back to the $50,000 account size, and 100 share lots (assuming all trades the same number of shares for simplicity), you need to end up with $4 total profit per share at the end of the day. So, let's say that you trade 100 share lots, and your profits for each trade are +0.35, -0.10 (stopped out!), +0.85, -0.10, +0.10, -0.10, +0.15, -0.10, +0.95, -0.20 (oops! missed stop), +0.45, -0.10, +0.60, -0.02 (trade started looking like it was going to go against you, so you covered it), -0.10, +0.07, +1.40 (home run!), -0.10. Adding these all up (these profits are AFTER adjusting for commission - 2.4 cents for TradeStation), you get your $4 goal. Several notes here, though:

• You have some good entries - entries that were able to produce some gain - you have tuned your entry strategy to go in to only good reward/risk ratio trades
• You have about half winners, about half losers - with winners obviously needing to be larger in magnitude than losers
• You had some good volatility, and were able to get some nice moves - with only one "home run" counted
• You traded 18 round trips to reach your daily goal
• With 100 share lots, your risk was low per trade.

Some other random thoughts - this represents a "typical" day - some days will be better, some will be worse. To reach your goal, you must average $4 gain per day, with 100-share lots. If you want to increase the risk (you need to decide what level of risk is acceptable - risk meaning that you might lose your WHOLE account), you can get to your goal more quickly. With 200-share lots, you would average half as many trades, or with 400-share lots, you would average one fourth as many trades.

The beauty of daytrading is that the income is linearly scalable. You can make as little or as much as you like (until you get to large enough orders that the liquidity for a stock can't handle your size). Let's say you can average (counting losses, small and medium gains, and home runs, and accounting for commissions) 0.20 per share per trade. To make $100 a day, you need to trade an average of 5 round-trip trades of 100-share lots. To make $400 a day, you need to trade an average of 20 round-trip trades of 100-share lots, or 10 trades of 200, or 5 trades of 400 share lots. You are making $400 a day, but you want $800 a day? You can double the number of shares per trade (remember to keep your risk level reasonable, though, so this depends on your total account size), or you can trade twice as many trades per day. Or - you can detect better setups, and increase your average profit per share.

• Read everything you can get your hands on. You will probably end up with a simple set of strategies that work for you - but you should at least know about others - and how strategies can be used in unison to give confirmations of good trades. If you buy a system, or take a training class, you may be able to get a jump on this part of the learning curve, but these purchased / mentored systems still require you to practice, study, and comprehend.
• Keep a trading log. When you put on a trade, note the results - why did you do that trade? What was the result? What mistakes did you make? What did you do right? How could you have handled the trade better? I did this for a couple of months, analyzing each trade. Then I started doing daily notes - indicating things that I had learned that day, revelations, goals, general comments, etc. Currently, I only note trades or conditions that were different from previous ones - trades where I learned something. This is a great source to review - and it also can give you a sense of how your training is progressing.
• Get a reliable trading platform that offers acceptable commission rates. I use TradeStation which provides Level 2, Time and Sales, charting, account management, user-programmable strategies and indicators, and backtesting capability (to test your strategies on historical data). The commission rate is 1.2 cents per share (larger orders get cheaper) - so that means I need to make 2.4 cents per trade per share to break even - very easy to calculate.
• Learn how to do Limit orders and Stop Limit orders. Market orders will eat your lunch. The only time I use a Market order is when I've capitulated - the price blew through my stop without triggering it (or I didn't get the stop set before the price moved against me) - and I want the miserable "Just get me out NOW" thing to happen. I've learned that in this case, it's often better to use a Market order than to try and chase the Limit orders down. If a stock is dropping quickly, you may not get the Limit order placed quickly enough, and the price may pass the Limit price before you can react, and then the stock price is substantially lower, and you still don't have an out.
• Online live chatrooms are often an excellent place for support (emotional and moral), questions, learning, teaching, and getting trading ideas and sharing alerts of trading conditions. I use Traders Wire Interactive - a great group of people, some good talent, and good place to learn.
• Paper trading? Yes, but not too much. You might want to do that just to get the flow of decision-making going - but the best way to learn is to DO the trade. Use small lot sizes (100 shares) to minimize your "tuition" losses. When you paper trade, there is a very strong tendancy to rationalize (Ohhh, it went down 3 more cents, I'll buy here instead of where I just did), and to idealize the trades (Let's see, I would have sold it at the high of this bar). Prices sometimes move quickly - you may not be able to get that high-of-the-bar price, you may not be able to get a Short fill, you may not be able to get a fill at all - or maybe just a partial fill (maybe only 22 shares of the 100 you wanted). 20/20 hindsight glosses over all the mistakes you could have made - and also gives you precise data after-the-fact, where in real life, you would have been making the trade decisions BEFORE the prices were known.
• Remember the KISS principle - Keep It Simple Stupid! As you put together a set of tools and strategies that work for you, try to keep it as simple as possible. Simpler strategies mean less work for you, less thinking, less chance of error, and faster decision making. If you have a strategy, and then you have to check five or ten other things to confirm the setup, the setup may be gone by the time you decide to get into the trade.
• You need to find a stock scanner (several free ones available on the web) to use when researching which stocks may offer tradable conditions. I highly recommend Worden Brothers TC 2000.
• ALWAYS ALWAYS ALWAYS have a Stop Loss order. This may be a "real" stop loss order, placed on your trading platform, or it may be a mental stop. Also, plan your target for profit, and once it's attained, either liquidate, scale out (sell part of the order), or move the stops up tight enough to keep most of the profit
• Have a grasp on the reward-to-risk ratio BEFORE you enter a trade - PROTECT YOUR PRINCIPAL - if the risk is higher for a particular trade, you may want to lower the trade size (in shares)