PART II

Day Trading

If you are not yet consistently profitable, you should not be looking at one- or two-point scalps in the Emini or 10 to 20 cent scalps in stocks as the cornerstone of your trading. In fact, you should avoid scalps until you are an experienced trader, because you need a very high winning percentage to be profitable, and that is difficult for even experienced traders to achieve.

The first consideration in day trading is the selection of the market and type of chart that you want to use. It is best to trade stocks that are popular with institutions, because you want to reduce the chance of manipulation by a specialist or market maker, and you want minimal slippage. There are so many great trades every day on any basket of five to 10 stocks that you won’t have to resort to stocks with small volume that might carry additional risks.

The more bars in your day, the more trades you will make, and the risk will be less per trade. However, you might not be able to read the charts fast enough to see the setups, and you might not have time to place your orders without an unacceptable level of mistakes. Also, some of the best trades happen so quickly that you will likely miss many and then be left with all the trades that are less profitable. There is a mathematical sweet spot that you will have to determine based on your personality and trading abilities. Most successful traders can trade a 5 minute candle chart. The price action on a 3 minute chart is very similar and offers more trades and smaller stops, but in general it has a lower winning percentage. If you find that you are missing too many trades, especially the most profitable trades of the day, you should consider moving to a slower time frame, like a 15 minute chart.

You can also use charts based on volume (like each bar representing 25,000 contracts) or ticks (for example, each bar representing 5,000 price changes or ticks) or simple bar charts. Line charts are also tradable, but price action traders are giving up too much information when they cannot see bars or candles.

In general, since your risk per trade is smallest when you day trade, you should be trading your maximum number of contracts. Warren Buffett was quoted as saying, “If it’s worth a penny, then it’s worth a dime.” Once consistently profitable traders have decided that they have a valid entry, they need to be prepared to trade a reasonable number of contracts.

Traders are always thinking about the best way to maximize their profitability, and the two most important considerations are trade selection and position size. A new trader should focus primarily on swinging only the best two to five entries each day, which are usually second entries in the form of reversals at new swing highs and lows on nontrending days (maybe 80 percent of days), and spikes and pullbacks on trend days. Once a trader is consistently profitable, the next goal should be to increase the position size rather than adding lower-probability entries. If a trader consistently nets only one point a day in the Eminis but trades 25 contracts, this comes out to over $1,000 per day. If the trader can get up to 100 contracts, he will make $1,000,000 per year. If he nets four points a day, that is $4,000,000 per year. The Emini and Treasury bond and note markets can easily handle this size of trading. For very liquid stocks with prices over $100, an experienced trader can net 50 cents to a dollar on most days, and these stocks can handle 1,000- to 3,000-share orders with minimal slippage. Exchange-traded funds (ETFs) like the QQQ can handle 10,000-share orders, but the daily range is smaller, and a more realistic daily net profit would be about 10 to 20 cents for a good trader, or a couple of hundred thousand dollars a year.

If a trader was managing a fund of $50,000,000 and trading 1,000 Emini contracts per trade (he might have to split his orders into 200- to 400-lot pieces), and he netted only a point per day, this would generate $10,000,000 for clients before fees. Concentrate on taking the best trades and then increasing your volume.