Short-Term Trading Strategies
Short-Term Trading Strategies
Cory Mitchell, CMT
Short-term trading strategies have made successes of many traders, and have decimated many more. The lure of quick profits can entice many people into the markets, but they find out that the potential for quick profits brings about equally quick losses. Yet great rewards can be attained as long as the trader does not approach the markets with a “gambling” mentality and realizes that in order to day trade and be profitable at it over the long term (or for a living), consistency is the key.
Losses need to be kept small, and profits can not be cut off too quickly. This needs to happen everyday for the trader to stay in the game, if losses are allowed to get to large and outstrip profits which are cut short, trading capital will dry up. In addition to this, money must be managed very closely, with capital on each position monitored and position size strategized as to maximize profits while minimizing risk.
The thing I have found with many want-to-be day traders is that they fail to realize that that if they want to day trade successfully, they need to do it day after day in a profitable manner. Windfalls do not occur as often as we would like to think. Many swing for the fences everyday, and while they make money intermittently, generally this strategy will lead them to an empty trading account. Statistically a trader will be right some of the time without any analysis or plan at all. This is the nature of the market. But to stay trading for the long haul the trader must beat the odds day in and day out (on average). One big win means nothing to a successful day trader, other than maybe providing themselves with a personal reward. Being constantly profitable is what the successful trader strives for, not immediate satisfaction.
Managing Risk
I recommend that a trader (any trader) risk no more than 1% of their trading capital on any one trade. As the trader’s account grows the risk assumed on each trade will fall to 1% or lower. Many traders do not understand what this means, mostly because they have never devised an entire trading plan, and thus have no real business trading anyway.
What risking 1% of capital on a trade means, is that on a $30,000 account the trader can afford to lose or risk $300 on a simple trade. All the day traders capital (all $30,000) may be tied up in a single stock, and that will happen often in small day trading accounts, but the 1% rule can still be followed. If 1000 shares of a $30 stock are purchased (excluding commissions and fees) the trader would have all his capital invested in that one stock, and if the stock fell to $29.70 the trader would be losing $300 at this point (30 cent loss on each of the 1000 shares) and would have to exit the position. While risking 1% of trading capital is not always the most prudent exit point for losing trades, it should be the maximum loss that is a taken on a trade. Losses can be taken must early than this and those exits will be laid out before each trade is made.
The trading plan is covered under the Trading Plan page of this site, but in summary the plan should detail entry points, profit targets, stops and trailing stops, and how money will be managed.
Many people are often drawn to day trading because they don’t have much capital and believe that they can accumulate more capital quickly by day trading. It is true, this can be done, but small accounts are hindered by three main problems (keeping reading if you only have a small amount of capital to trade, I may have a solution for you below) which will be discussed. First of all, on small accounts commissions and trading fees can quickly become a massive obstacle to overcome when positions are relatively small due to lack of capital. Secondly, with a small amount of capital it is often hard to stay in the market through normal volatility in anticipation of the larger move.
Small traders may be right in their analysis, but get stopped out before the profitable move because their accounts can not handle normal market volatility. Lastly, a small account, due to the smaller positions taken, will take longer to start generating enough money to supplement or replace other working income (relative to a large account which can take large positions and thus generate larger profits in dollar terms).
I have known many people that have wanted to start day trading, but couldn’t because they lacked the capital to do so (you must legally have a $25,000 minimum balance to open and maintain a US day trading account). This is unfortunate, but I have finally found a product that will help those potential traders who have limited capital but possess the dedication to make themselves successful.
To me, forex trading and forex brokers are best thing for traders with little capital. Risks still need to be controlled, but the forex and CFD market have much lower barriers to entry. Read this intro to the forex market to learn a little more: How to Trade the Forex Market even with Very Little Money
Short-Term Trading Strategies
For a whole pile of strategies and trading lessons please see the Trading Tutorials page. Below you will find some simple short-term trading strategies that are based on indicators, which you can personalize and build on.
Momentum Play:
Buy (sell) a momentum stock after it has moved higher (lower) than its morning high (low) after the first pull back from the morning high (low) has taken place. Trades should not be entered in the first 15 minutes of the market open with this strategy. All trades should be in the direction of a longer term trend.
Apply this strategy to stocks that have shown longer term momentum. A list of such stocks can be generated by running a screen for: top (bottom) performers in a sector; 52 week highs (lows); Certain % percentage of above moving average(s); Exchanges top dollar or percentage gainers for the week or month. Any screen that isolates stocks that are in a trend or likely to move should be OK.
Other indicators can be used to give trade signals validity. For longs, additional signals could include: MACD making new highs on moves above old highs; ADX line on DMI indicator rising with the positive line above the negative line; A short term moving average crossing above a longer term moving average; Volume increasing in the direction of the move. Any one or a combination of these tools (or the many possibilities not mentioned here) can be used to further validate a trade signal.
Stochastic Followthrough:
A stochastic shows a stocks ability to trade in the upper or lower range relative to the analysis period. Stocks that are in the upper part of the range (above 70) and the lower part of the range (below 30) are exhibiting signs of strength and weakness respectively relative to recent performance. This strength or weakness can be exploited by short term traders. While a stochastic reading at these levels (above 70 or below 30) is often considered overbought or oversold, strong stocks will spend more time in the upper half of their range and weak stocks will spend more time in the lower half of their range. This means that we can take advantage of strong or weak stocks at points when they are showing above average strength or weakness. I call this movement a “followthrough”.
The Strategy: In an up trending stock, buy when the slow stochastic line crosses above the 70 with the fast line still pointing up. Sell a downtrending stock when the slow stochastic line crosses below 30 with the fast line still pointing down. Cover longs when fast line crosses below slow line, and cover shorts when fast line crosses above slow line.
Range Trading with a Stochastic:
Often the overall market will not be trending, but will be range bound instead. Certain markets and stocks can be in trading ranges for long periods of time, thus it is good to have a strategy for such times.
Ideally when range trading, the futures should not be trending. Only stocks that offer a decent profit potential should be traded, assuming you will be able to enter and exit within 20% of the range extremes (trade captures 50-60% of the move approximately). Heavily traded stocks will often have smaller ranges, but more shares can be taken. Thinly traded stocks often have larger ranges, but less shares will likely be traded. Avoid playing narrow ranges in thinly traded stocks as the profit potential will likely be small.
The Strategy: Short the stock when the slow stochastic line has crossed above 80 and is now moving back down through it. Ideally the fast line should be pointing down. Go long when the slow stochastic line has moved below 20 and is now crossing back above it. Ideally the fast line should be pointing up. Exit shorts when the fast stochastic line crosses above the slow stochastic line. Exit longs when the fast stochastic line crosses below the fast stochastic line.
Moving Average Crossover:
This strategy is used to indicate short to long term trend reversals.
Choose two moving averages of different lengths. One should be a short time frame (your fast line) and the other should be a longer time frame (your slow line). The time frame each moving average is assigned will be decided by each individual trader based on the amount of signals they want to generate, or false signals they want to eliminate.
The Strategy: Go long when the fast line crosses above the slow line from below. Additional confirmation can be gained by using other indicators. A MACD or DMI indicator should be showing an up trend emerging. Volume should be stronger on rallies than it is on declines. Money Flow indicators should be increasing. Any or all of these indicators could be used to filter signals.
Go short when the fast line crosses below the slow line from above. To further validate the signal the DMI or MACD should be showing a down trend emerging, and/or volume is decreasing on rallies, and/or Money Flow indicators are moving lower.
This strategy can be used on stocks that were screened for in Momentum Play strategy. To increase the safety of the trades, trade crossovers in the direction of the larger trend.
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