Know These Things About Every Day Trade

Constantly consider these factors while day trading

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While day trading, keep the following four questions in mind, in the form of a constant internal dialogue. That way, when a trade develops you can take it without hesitation, and in full confidence that you're doing so based on your trading plan.

1. What's the state of the market?

It's an error to assume what the market will do. Instead, always clarify what it is actually doing. Is the market trending or is it within a range?

Is it forming a chart pattern such as a triangle or a head and shoulders pattern?

This automatically helps you filter out poor opportunities and spot good ones. If you use a trend trading method, only trade if a trend present. If you trade chart patterns, then you have a potential trade if a chart pattern is forming, but not otherwise.

Once you have assessed the state of the market, ask yourself "Is the market in the right state for my strategy?" If yes, proceed. If no, wait for the state of the market to align with your strategy.

If the market is not in the right state for your strategy, also ask yourself "What needs to occur for the market to enter the right state, and thus for me to start taking trades?" This question gets you thinking ahead, so that when conditions do turn more favorable, you're ready to pounce on the opportunity.

2. What's the volatility like?

"How quickly is the market moving, and how much is it moving?" This question helps you gauge expectations for the trade.

If the stock has only moved $0.03 in the last hour, but you typically try to make at least $0.05, then conditions aren't favorable for the strategy--there isn't enough volatility. If you do take a trade, you will need to adjust for the lower volatility, possibly contracting your stop loss and profit target.

If the price is swinging wildly (see: Find Day Trading Stocks with the Biggest Moves Using These Filters), and your strategy is based on calm and orderly market movement, then you'll likely want to sit on the sidelines until conditions stabilize.

How quickly, and how much, the market is moving also gives you an estimate of how long trades could last. If you prefer trades that last a short amount of time, trading when the market is moving slowly is ill advised. Trading under such conditions will have you pulling your hair out, which in turn could lead you to deviate from your strategies.

Attempting to make split-second decisions in a fast moving market, when you're not prepared for it, can also cause disaster. 

Once you've assessed the volatility of the market, ask yourself "Is the market in the right state for my strategy, and am I comfortable (have I practiced) in this volatility?" If yes, proceed. If no, wait for market volatility to align with your strategy.

3. What's the entry and exit plan?

How, and when, you enter and exit a trade is laid out in your trading plan. Reaffirm your entry and exit rules constantly while you trade. This helps keep you on track, trading your strategy and not taking random entries and exits on whim.

 

Before every trade know how you will enter and exit, based on your strategy, the current state of the market and current volatility. 

When you know how you will enter and exit--both winning and losing trades--then move on to the next step.

4. What's the risk? 

Having an exit plan (step above) is knowing how you'll get out of both winning and losing trades. Losing trades are controlled by a stop loss order. The difference between your entry price and stop loss price, multiplied by the position size, is your risk.

Risk should represent less than 1% of your account capital. If the trade presents more risk than that, skip it. For example, if trading a $35,000 account, and risking a maximum of 1%, the risk on the trade must be less than $350. If the risk is greater than $350, avoid the trade. 

Risk thresholds vary by trader but risking 1% or less of account capital, per trade, is recommended.

Final Word

Successful day trading isn't the result of whims or taking random trades. There is a process to every trade. Continually assessing the market and your trading opportunities based on these four questions will help keep your trading on track, in alignment with your strategies and trading plan. 

The answers to each question let you know if you should even be trading. They also help you to think ahead, so when opportunities come along you're ready to pounce with well thought out entries and exits. They help you assess the risk/reward of your trades, and whether the trades are worth taking based on the risk they present.