Investing Tools for Investors Looking to Excel
10/21/02  

Chart patterns, volume characteristics, news analysis, and economic data releases that reveal positive or negative short term trading opportunities. Head and Shoulders, Cup and Handle, Fibonacci Retracements, trendlines, moving averages, the significance of volume and trading ranges, plus much more is discussed here.                    

 Day Trading

 Using a variety of techniques ranging from guesswork to hot tips to technical to fundamental techniques, day traders attempt to enter and exit in the same day at a profit. Some will take either long (betting on a price rise) or short (betting on a price decline) positions. Recently, many daytraders have convinced themselves they have the midas touch because of the Internet phenomena, which have carried some stocks to amazing gains. Later, we will review a variety of approaches to entry and exit and tell you how to get daily long and short ideas.

The important thing in all investment approaches is to understand that not every pick will work. In fact, if 60% of your picks outperform the market, you're doing very well. The key is to let your profits run and to exit losers with predetermined stops (more about this later). In other words, if you can quickly exit your losers, and stick with your winners, you can seriously outperform. For instance, if 60% of your picks rise 15% in a given period and you exit your 40% losers stopping your loss at 5%, you can produce a good overall return. Specifically in the case, you would earn 7 %, derived as follows;

60% @ 10% gain= 6%

40% @ 4% loss = (1.6%)

Net Return= 4.4%

The objective is to repeat these levels of gains many times a year, creating significant outperformance.

Easy to say, difficult to do. The human tendency is to never sell at a loss until it gets back to even, and take profits as soon as you have one. Waiting for a loser to return to break even can take months to years, and totally disregards the time value of money and opportunity cost. Technical analysis can assist in predetermining targets, exit points, entry points, as well as setting critical protective stops. Importantly, one should not fall in love with your positions.

Further, one should establish a stop loss. Sell stops should be mental or literal and should be established under long positions either at a point just below an important moving average, trend-line or area of past purchases.   There is an old expression, particularly true for aspiring day traders. "An investment is a short term trade gone bad." Stop losses can prevent you from having dead money if a position goes against your expectations and, inevitably, they will. For short positions, one should establish protective buy stops above the point of entry, just above the next major moving average, trend-line, or area of past purchases, in order to prevent the position from really harming your results.

It is important also to establish an appropriate and reasonable risk/ reward ratio. We suggest 3 to 1. In other words, a reasonable gain to your target price that is 3 times the possible loss if your protective stop is triggered.

It is possible to use all these tactics and pass your investment ideas through a number of different screens or tests. If an investment can meet a number of criteria, you most likely have increased your odds for outperformance.

Since much of day trading buying and selling is technically motivated, it is critical, at a minimum, to read the technical investing section, and understand the types of patterns that can represent good setups. However, we repeat the major patterns below.

  Buy Patterns

Day trading purchases, for the most part, look for high volume breakouts, 1-2-3-4's type countertrend retracements, double bottoms, retracements to important moving averages and/or other major support with oversold conditions at support, and breakouts from bases. Further, high volume exhaustion sell-off breaking lows for the 20 preceding days with the stock trading near the top of the daily or, even better, above the gap down open, is good trading buy signal the next morning on an up-tick. This is called a key reversal day. The reversal strategies can be difficult because they can indicate a breakdown or an exhaustion of overdone selling.  Let's summarize these buy signals.

Each position is best established with a wide trading range in addition to heavy volume, with a close at least in the top 1/4 of the day's trading range.

Sell or Short Patterns

Day trading short positions desire breakdowns in topping formations, 1-2-3-4's in tops or retracements, failed or failing retracements up to overhead support, failed retracements to important moving averages (50 day is most common for day traders) or downtrend lines.

Fundamental Day Trading with Economic Timing and Market Timing

This involves using three styles to pick off short term profitable trades. Specifically, let's say there is a growing consensus the economy is heating up, that inflation is around the corner, and financial and defensive stocks (utilities, consumer non-durables) are going to be losers and as a result, these issues have traded down to major up-trends, retreating as much as 25% in the process. Further, let's assume that cyclical issues (sensitive to a scenario that would improve unit volumes and pricing power) have traded up substantially into overhead resistance, but still substantially the 150 and 50 day moving averages.

Let's next assume that a major economic announcement completely challenges that new consensus of a possibly overheating economy. The financial and defensive issues can rally, while the cyclicals will trade off from overbought areas. This use of styles in concert can lead to very positive results providing one moves quickly on the news and knows what to do. Economic data is normally announced at 8:30 AM or 10:00 AM. Occasionally, the first announcement can trigger a buy while a second announcement may confirm the consensus view causing a whipsaw. This happens and if you don't have the temperament, you shouldn't be trader.

Using these disciplines, day traders can produce some serious out-performance. But one needs computing power to unearth these positions and the emotional stability to handle the pace. Further, your portfolio turnover and bookkeeping will be prodigious.

Disclaimer

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