Right from the start, we will be honest with you – we do not recommend a day trading strategy and this strategy goes against the very concepts of value investing and against all the strategies that Warren Buffett espouses. While value investing focuses on investing for the long term, this is the opposite strategy, it focuses on buying and selling within a very short period even within a day.
Day Trading
The strategy can pay off if you find stocks that fluctuate greatly during the day, then these would be ideal stocks to buy low and sell high. You could look for stocks that just took some dips and then purchase quick and hope for a small increase. Many stocks will fluctuate in price throughout the day. If you take any stock and put an offer to buy at 50 basis points below-cost or lest say half a percent below cost, then sell it at half a percent above. This could result in a gain of 1% for the day, that would be an extremely profitable day, but if you were to aim for 0.5% gains, so half of the full percentage point. Let’s say you were able to do this three days out of five, this would mean that in a week, you could have a gain of 0.5%, if this could be repeated throughout the year, this could result in a very positive situation. If this is coupled with your other investments, then this could result in a strong portfolio.
It would be advisable to try this technique with a small sum that you can afford to lose. You must not use the main sums that you need to grow your main portfolio. Let us say that in a year you invest in your main portfolio for about $36,000 per year or $3,000 a month. Then take one month and use that to practice with day trading. Follow a strategy where your goal is to be able to increase this sum by on average 0.5% per week. If this can be sustained, then you will have this fund grow very quickly. You might see that the rate is closer to 0.1% per year, which is still a good result, and over 52 weeks, you will see a 5% increase in your portfolio for your day trading stocks. Then you should continue with this strategy and in year two and another month of investment to that portfolio. Keep with this until two things become very clear, if you are making much more money than the rest of your portfolio, then it may be time to consider increasing the percentage of your portfolio that you are working with. If on the other hand, you are losing funds, then it is clear that you should be limiting the amount of funds that you put here. You may even want to consider halting this experiment after a year or two if you are not getting the desired results.
More Work less Pay
At the end of the day if you are working many more times as hard and getting less results, then it would be a good time to cease that activity. The one exception to this rule would be where you are either getting much better at it and you see your results improve each year or you just love this type of activity. In that case, keep the amounts small and continue to learn with this process, but make sure that you spend no more than a fraction of your total portfolio and you maintain the contribution to your main portfolio.
You must always remember to pay yourself first. That would be the sum that you invest into your main portfolio using the primary approach at 80 or 90% and the rest using the value approach. Then perhaps a very modest sum can remain to try out the hand of day trading. Do not invest heavily here until you practice on small sums and understand how to effectively minimize your risk. If you are consistently losing funds, you should also cease this activity.
When day trading, it is wise to choose very volatile stocks and also stocks that you feel are a good investment, on days where you feel your stocks have a loss, you can decide to hold on and only sell at a gain or a reduced loss. You are not forced to sell at the end of the day. This would be a good approach. You should aim to focus on three stocks in your day trading, this way one will be a gain and the other a loss, and hopefully the third is also a gain. If you have two losses, you could decide to sell on and hold the other for another day. Until you now have two gains and one loss. If it turns out that all three lose, then you will need to take at least two of the losses and hold one for a bit longer, hoping that it will regain the loss the following day.
Minimize Risk
You can set sell prices, so this way you can ensure that when the stock prices increase, you take advantage of and get the sale. The downside with this approach is that you may sell below the plateau point. But there are risks for each approach. These types of situations will occur but your goal will be to make the overall small gain. It is important to note that this approach is not easy and most stockbrokers do not gain on the market by day trading. If there was a person that was able to do this successfully, they could create a mutual fund with great returns, but this is very unusual and if it occurs from time to time it is very difficult to replicate. There are very few investors with the track record of a Warren Buffett and even fewer day traders with a performance like Warren Buffett. Ask yourself if you would like to spend hours each day focussing on day trading or spend a couple of hours or a few minutes a month and achieve better results. The answer for most would be to spend less time and achieve better results. Hence, the best option would be to go with the Warren Buffett approach and avoid the day trader approach. This is our overall recommendation until someone can achieve Warren Buffett’s results with day trading, then best to stick with value investing.
There are many strategies to use in a day trading environment, the first strategy would involve following the trend.
With day traders it is important to realize that you are looking for small gains on sales and with a few sales per day. In the beginning, you may start with one trade per day, or one stock, which is one buy and one sale. The goal here is to get in and get out within the day and make a profit. It is important to make profits on at least 50% of your trades and ideally closer to 60% of the time. You are also focussing on very small gains. If you aim for a 0.5% gain or perhaps as high as 1%. Your fee structure compared to your gains and size of investment mustn’t start eating into your profits. Hence, if you are paying $5 per transaction, this means that two transactions will be a $10 fee, if you are aiming for a 0.5% profit, the minimum size would need to be $200. But of course, if you make an investment of $200 and you gain 0.5%, there you have your $10 profit, but your fees ate up your profit so you are left with zero. Hence, to even make a dent into this, you should be looking at a minimum investment of ten times this amount and ideally closer to 100 times this amount. At $20,000 a 0.5% gain now equals $1,000 and the $10 fees are less a factor. Keep this in mind and focus on getting the smallest transaction fee that is possible. If your fees are much lower, then you can work with a much smaller investment. If your costs are $1 per transaction, then you could work with an investment of about $4,000.
Limit Orders to Minimize Risk
You also need to have strategies to minimize your loss. You do not want to choose the wrong stock and then that stock falls to the floor and along with it, your investment. It would be important to have a strategy to stop these losses. One way to do this would be to have limit orders to stop any huge losses. The great thing about these limit orders is that they will prevent losses but will not prevent the potential gains. Hence, they should be used in the arsenal of every day trader. Ideally, your goal is to make consistent and small gains every day. Also, keep in mind that if you put a limit order to reduce your loss to 2% of your investment and that limit order is affected, you just lost 2%, and that will require you four wins at an average of 0.5% gain to break even. Day trading is a very risky endeavor and one that we do not recommend. If you do try it out, you need to follow many techniques and practice with the smallest sums that you are fine with losing.
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The goal of day trading is to get to the point where you can regularly earn 1% or more per month. This means over thirty days, you would need to win 16 times and lose 14 times. This will give you positive results. If your portfolio can grow at 1% per month, this is a fantastic result and will have you earning over 12% per year. The amounts can be compounded, assuming you increase your investment with each month, according to your gains.
The strategy that is fine is to take a sum that you are fine with losing. Say that sum is $5,000 and tell yourself that this $5,000 sum is to teach yourself how to day trade. Then use some of the advice we give in this document, but also speak with others. Every situation is very different and without direct communication with you, we can only give a disclaimer and say that anything you do without consulting us directly would be done at your own risk and the only thing you can expect is to lose your full investment. Speak with us directly or with other professional investors to find out the exact strategies that work.
However, if it costs you $5,000 to become a knowledgeable day trader and perfect your skills with this, then you can make very large sums of profits in a short period. Hence, it is not money thrown out the window. As well, if you do very poorly at it, you will also learn that day-trading is not for you. This is also money well spent. We cannot say it strongly enough, we do not recommend day trading, it is extremely risky and if you do it incorrectly you could easily lose your entire investment. Having said, only invest a sum that you are perfectly willing to lose at the cost of learning the skill of day trading. If you are very unsuccessful at it, then end it with the knowledge that you gave it a try and it was not for you.
Some strategies that day traders use
1: Trend Following: This strategy assumes that when a stock is on the rise or on the fall it will continue to do so for some time. While this is true, it will also change direction at any point. So it is important to know when it will turn around. If we take the case where the stock is on the rise, the will buy it at the market price or put a limit order in to buy. Then once they own the share they will put a limit order to sell it at a gain, they may also put another limit order in to prevent a loss. This would be their strategy, once it has achieved the desired gain, they would then sell. If they sell at the gain, they would have earned their target surplus and move on to the next day.
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Various Day Trading Investment Strategies
On the other hand, if a share is decreasing in value, the other approach is to short this sale, in other words, sell it first and then buy it later, so they would short the sale at the market, let us say that is $100, then they are looking to buy it at $99 or $99.50, depending on if their goal is 1% or 0.5% gains. It is important to note that shorting a sale can be very risky. If you short a share and its price skyrockets upwards, you are left with a huge loss between the selling price that you sold and the new purchase price. Let us say that you shorted a stock at $10 and then the market decides that stock is a strong buy and within a few hours the stock moves up to $100. If you had invested in 1,000 shares, you would now have proceeds of $10,000 and a cost of $100,000 or a net loss of $90,000, this is many times the multiple of the proceeds. This is why shorting a stock can be very dangerous. If you get it wrong, there could be deadly consequences.
2. Daily volatility gains, also called Daily Pivots, this strategy looks for stocks that fluctuate greatly within the day but generally fall within the same range. Imagine a share that has a history of fluctuating from $99 per share until $101 and does this a couple of times a day. You could then buy at $99 and sell at $101 or perhaps do a limit buy at $99.5 and a limit sell at $100.5. If you do this each day, you would make 1% for each buy and sell transaction. This is a very common approach and can be used quite effectively even when the stock remains at a consistent price. The great thing about this strategy is that there is far less risk, especially if you make sure that you do not short the stock first. Always start with a purchase, never start by shorting a stock.
3. Positive or negative news momentum, this is very similar to the first strategy, but the difference here is that the momentum is caused either by some positive news or negative news. The same strategy would then follow.
4. Looking for candles. This is the process of looking at the chart histories, there is a lot of data to back this up. However, it is far too detailed to go through it now. We will review evaluating candles in a later article.
Overall, we consider day trading to be very risky and very time consuming and hence our recommendation is more in the line of following value investing. Which we will cover in an upcoming post.
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