Getting Started with Day Trading – A User-Friendly Guide for Beginners
Many of concepts we have listed in this comprehensive guide are derivations from Tim Sykes’ beginners guide to day trading. We have added content where necessary, and we are confident that the content will serve you well, no matter what day trading stocks you pick.
Day trading is best defined as buying and selling stocks within the course of a trading day. In other words, traders open and close positions on the same day. On rare occasions, day traders may hold positions overnight. A classic example of a day trade would be buying stock ABCD at $0.50, and selling stock ABCD at $0.75. In this example, the stock rose by just $0.25, but that represents a 50% appreciation. Had you invested $1000 in stock ABCD at $0.50, and sold it at $0.75, your profit would be $500 (barring commissions, fees, hidden costs, trading charges et cetera). On the face of it, it looks relatively simple to day trade. Don’t be misled by these types of rudimentary examples – there’s a lot that needs to be learned about day trading stocks.
You probably noticed that stock ABCD trades at under $1 per share.
The stock is clearly a penny stock, but any stock valued at less than $5.00 is considered a penny stock according to the Securities Exchange Commission (SEC). Penny stocks are the preferred choice of many expert day traders, owing to the high profit potential in these stocks.
Why penny stocks?
It’s simple really! Penny stocks are extremely volatile. They also lack liquidity. This combination can bode well for day trading purposes. A new product or service which hits the headlines could see its stock price soaring.
Much the same is true if a start-up company with a low-cost stock option successfully negotiates a contract, buyouts, acquisition, or simply generates interest from an established company.
Let’s assume company ABCD makes apps for space mapping. Perhaps Microsoft, Facebook, Google, or Tesla would be interested in such an app? If the product or service being created by the SME is picked up by prominent investors, this would be a great reason to buy stock ABCD.
If, by chance you have been following the space mapping industry and you find a substitute product which is even better, you may want to short stock ABCD before the company’s market capitalization tanks.
What’s the Difference Between Day Trading and Investing?
Luckily, this is an easy question to answer. Trading involves buying and selling, usually within a short time interval. The objective of trading is profit. Buy low, sell high. Or, short the stock and profit accordingly. When you trade, you don’t have to have faith in the stock, or be connected to the company.
In fact, it’s best if you can act with surgical precision – timing your trades to perfection, buying at the right price, and cashing out accordingly. Investing is a long-term proposition. An investment is a clear indication that you have faith in the long-term viability of a company, and its stock.
Some traders liken trading to a one-night stand, and investment to a marriage!
How to Pick the Right Day Trading Stocks
The first thing you will notice about the stock market is that there are thousands of financial instruments available for trading. It’s difficult, if not impossible, to manually check the list of daily trading opportunities. That’s where powerful technology comes to the rescue. Stocks screeners such as Oracle at Stocks To Trade (STT) have passed the litmus test in this regard. By automatically evaluating the top stock movers, with the highest volatility, a powerful stock screener can be customized to personal expectations, making it ideal for casual traders.
The actual process of trading a stock is peppered with directives, foremost among them a sound trading strategy. While many people mistake the objective of trading to make money, the true benefit is learning how to become a better trader.
With the right education, determination, and prognostication, you can make money trading penny stocks. It’s not a shot in the dark – there are definite tools at your disposal, including news and media reports, statistical charts, graphs, and analysis, and of course patterns.
Practice First Then When You’re Ready Trade for Real
Before you get started with a day trading account, it is a really good idea to register for a demo trading account a.k.a. paper trading. Demo trading takes place under real market conditions, without real money. You perform all the same actions as a real money trader, with zero risk.
While it’s easy to go big with paper trading (trading erratically and without regard) this should be guarded against. Stick to the basics when trading online – set a trading budget and don’t deviate from it. Never over-commit yourself to any individual trade. There are numbers to help guide you in this regard.
For example, in investing, there is a 5% rule in place. This states that you should not allocate more than 5% of your available budget to an individual investment. Some traders like to go even lower than that, perhaps even 1%. This means that a $1000 budget could be split 100 ways with $10 trade allocations each at 1%, or 20 ways with $50 trade allocations at 5%. It’s up to you to determine what figures you’re most comfortable with, but be conservative. Go slow and learn while you are trading, rather than experience a blowout and be too scared to ever go back.
This allocation of funds towards stocks should reflect your particular areas of interest too. As you build a portfolio of different options, be sure to maintain a manageable amount of trades. Start small and slowly expand as you gain knowledge, experience, and success. The mix of assets you choose should also allow you to withstand sudden and dramatic movements in the market. Balance is the operative word.
One of the most useful tips for new day traders to follow is this: The trend is your friend. By following trends, and patterns, you will be better equipped to make the right buy and sell decisions when they are available.
Should You Use Margin and Leverage When Day Trading?
Margin trading is basically borrowed funds from the brokerage. Avoid it at all costs. It is extremely risky, and if trades don’t go your way, you are liable for all the losses. If the trades go your way, you will be smiling all the way to the bank, but most day traders are not profitable, especially novices. Avoid a margin account and trade with money that you actually have to spare. Leverage is how you can trade a much larger position than you would otherwise be able to. In other words, you are leveraging a small amount of money for a much bigger trade.
An example puts everything into perspective:
Let’s assume you are going to trade stock ABCD which is priced at $2 each. If you purchase 10,000 shares, the cost will be $20,000. If the shares go up by $0.50, your profit will be 10,000 x $0.50, or $5,000. The profit percentage is $5000/$20,000 = 1/4 = 25%. Now, let’s assume that there is a 10% margin requirement. Instead of putting down $20,000 upfront, you would only put down $2000 (10% x $20,000) = $2000. This is where things get interesting! Since your upfront payment is just $2000, and your profit is $5000, you are making 5000/2000 = 250% profit on your $2000 margin!
While it looks enticing, if the trade doesn’t go your way, you’re liable for the full amount.