DAY TRADING STRATEGY STEPS
You don't need to look to other traders, books, videos or
courses to find a day trading strategy, with a bit of guidance you can develop
day trading strategies of your own. One of the best ways to being your journey
into day trading strategy development is by using technical price patterns or
chat pattern. Price patterns are recurring themes you see day in and day out,
which more often than not lead to a certain defined outcome which you can
capitalize on. Finding these pattern and ultimately developing a strategy for
trading them will require five broad steps.
Money Management
Most successful trade traders risk less than one or two
percent of their account on each trade. Your first step in developing a
strategy is assessing how much capital you're willing to risk on each trade.
If you have a Rs50,000 trading account, and are willing to risk 0.5% of your capital on each trade, your
maximum loss on each trade is Rs250 (0.005 X Rs50,000). Knowing this amount will help determine if the entry
points and exit points you establish in the next two steps are feasible for the
amount of money you're willing to risk.
Entry Points
Entries only occur if the market produces a specific set
of conditions which more often not produce a favorable result for that entry
point. The specific set of conditions is outlined in our Entry Rules.
To come up with Entry Rules, look over a tick chart, 1-minute and 5-minute (or other times frames in
between). Look for large or trending moves where there was a great profit
potential. Was there a candlestick pattern which initiated the move? Could an
indicator have signaled an entry point? Is there an overall trend (longer-term
chart) which provided confirmation of the signal? Are chart patterns present,
such as a triangle, flag, pennant, or head and shoulders pattern? These are
questions to consider when assessing how to enter a position.
Specifically define and write down the conditions under
which you'll enter a position. "Buy during uptrend" isn't specific
enough. "Buy when price breaks above the upper trendline of a triangle
pattern, where the triangle was preceded by an uptrend (at least one higher
swing swing highs and higher swing low before the triangle formed) on the 2-minute chart in the first two hours
of the trading day." This is must more specific and also testable
(discussed later).
Once you've got a specific set of entry rules, scan
through more charts to see if those conditions are generated each day (assuming
you want to day trade everyday) and more often than not produce a price move in
the anticipated direction. If so, you have a potential entry point for a
strategy. You'll then need to assess how to exit those trades.
Exit Points
At minimum a strategy must have a way to exit both
winning and losing trades.
A stop loss order controls risk. For long positions a
stop loss can be placed below a recent low, or for short positions above a
recent high. It can also be based on volatility, for example if a stock price
is moving about Rs0.40 a minute, then you may place a stop loss Rs1.20 away from your entry in order to
gives the price some space to fluctuate before hopefully moving in your
anticipated direction. Define exactly how you will control the risk on the
trades. In the case of a triangle pattern for example, a stop loss can be
placed Rs0.20 below a recent swing low if buying a breakout, or Rs0.20 below the pattern. Rs0.20 is arbitrary, the point is simply
to be specific.
There are multiple ways to exit a wining position,
including trailing stops and profit targets. Profit targets are the most common
exit method, taking a profit at a pre-determined level. Traditional analysis of
chart patterns provides profit targets. For example the height of a triangle at
the widest part is added to the breakout point of the triangle (for an upside
breakout) providing a price to take profit at. The profit target should allow
for more profit to be made on winning trades than is lost on losing trades. If
your stop loss is Rs0.20 way from your entry price, your target should be more than Rs0.20 away.
Define exactly how you will exit your trades. The exit
criteria must be specific enough to be repeatable and testable.
Tactical Considerations
Decide what type of orders you will use to enter and exit
trades. Will you use market or limit orders? Also define whether you must wait
for a price bar to complete to trigger an entry or exit signal, or if you will
take the signal in real-time when it occurs. In the triangle breakout example
on the 2-minute chart, do you wait for the breakout bar to close above the triangle
before entering, or do you enter as soon as the price crosses above the
triangle trend line?
Tying it together
Once you've defined how you enter trades and where you'll
place a stop loss, you can assess whether the potential strategy fits within
your risk limit. If the strategy exposes you too much risk the strategy needs
to altered in some way to reduce the risk.
If the strategy is within your risk limit, then testing
begins. Manually go through historical charts finding your entries, noting
whether your stop loss or target would have been hit. "Paper trade"
in this way for at least 50 to 100 trades, note whether the strategy was profitable and
if it meets your expectations. If so, proceed to trading the strategy in a demo
account, in real-time. If it's profitable over the course of two months or more
in a simulated environment proceed with day trading the strategy with real
capital. If the strategy isn't profitable, start over.
The Bottom Line
A strategy doesn't need to win all the time to be
profitable. Many traders only win 50% to 60% of their trades, but make more on their winners than
they lose on their losers. Make sure risk on each trade is limited to a
specific percentage of the account, and that entry and exit methods are clearly
defined and written down. The method should be so precise, that even if you
don't trade for a year you should be able to look at what you wrote down and
know exactly what it means and what you have to do.
