The best way to make a profit through day trading is to keep it simple. However, while this is perfectly logical advice, many do not understand what that means. What's worse, it is difficult to find instructions and advice as to how to do things in a simple way.
Meanwhile, everyone is doing things their own way, and even if they are willing to reveal their strategies and other aspects, they still do things differently from anyone else. This is why we have decided to show you how to keep your day trading simple, by following only a few steps.
1) Create an efficient trade setup
In order to be good at trading, you need to start by organizing a good trade setup. This is important, as the market conditions continue to change all the time. As a result, your chart often gets filled with irrelevant information and other types of distractions. You need to filter what information matters and the easiest way to do so is to create a trade setup.
What this means is that you would introduce a custom set of conditions that must be met in order to confirm that the trade could happen. Of course, this will still result in each setup being different from others. However, that does not matter. What matters is that you decide which conditions need to be met before the trade is even possible. Until then, you don't do anything, and even when the conditions are met, you should use your judgment to determine if it is a good idea to interfere.
When it comes to the conditions that you may want to set up and wait for them to be met, there are plenty of different ones for you to choose from. You don't have to wait for all of them to be met, but you should wait for at least three of them to take place before beginning the trade.
Some examples of these conditions include:
A simple moving average crossover
A moving average is an indicator in technical analysis that helps smooth out price action. It removes the 'noise' that short-term price fluctuations add; it gives you a clearer picture of the price's movements. A crossover is something that happens when you are using two moving averages, each of which is based on different degrees of smoothing, such as a 50-day moving average vs. 200-day moving average). This is used to show current trends. The indicator uses a slower moving average and a faster one, although it can have more than two. When and if they cross, the crossover signals a change in trend, which traders can use to their advantage.
The RSI (Relative Strength Index) is the name for a momentum indicator, which measures the magnitude of recent price changes. That way, you can evaluate the price of an asset and overbought or oversold conditions in regard to the asset.
Divergences are spotted using Stochastic Oscillator, which is a technical indicator that is used for tracking the price's performance during a certain time frame. The indicator moves between 0 and 100, with 0 being the lowest that the price of an asset has hit during the time frame you are following, and 100 being the highest. A divergence itself is something that happens when the indicator doesn't move in-line with a price. For example, if the price surges or drops, but the stochastic doesn't reach a new high or low, you should be on guard for a potential change in price direction.
Fibonacci percentage retrace
A Fibonacci retracement is a term that refers to areas of support and resistance. Simply put, the Fibonacci retracement levels are using horizontal lines to try and determine where potential resistance or support levels for an asset price may be. Each level is tied to a certain percentage, and the percentage shows how much the price has retraced. The levels are specific, however, and they include 23.6%, 38.2%, 61.8%, and 78.6%.
Fibonacci extension percentage
However, there are also Fibonacci extensions, which are used to determine certain profit targets after the price experiences a retracement. Basically, after the retracement, the price is expected to make a move, and the Fibonacci extension percentage is used to try and predict how far the price may travel once the pullback is finished. As the name suggests, there is also a certain percentage that is used here, including 61.8%, 100%, 161.8%, 200%, and 261.8%.
Major support level
Major support, or major support level, is a price level that the asset's price usually does not fall below. When you track an asset's performance via the chart, you begin to see how far down it goes, and sooner or later, there is a commonplace where the price drop stops. This is considered a support level. There are also smaller support levels that stop the asset's price drop as well, although they may be broken during major price movements. Major support levels usually do not experience the same except in extreme price movements.
When the price is volatile and it often goes up and down by a certain amount, its chart displays this movement in lower swing high peaks and higher swing lows. You can use the former to mark the highest points that the price reached each time it surged, and the latter to mark the deepest depths it reached each time it dropped. Moving a line through the highest points shows the downward trendline, and moving one through the depth marks lets you discover an upward trendline. When the price comes to one of the trendlines and touches it on the 3rd, 4th, or 5th peak/low, that is when you should buy or sell.
However, it also happens that the price bounces off once it reaches a trendline, which means that it is obeying the trendline. Alternatively, it might also break it, which is also a scenario for which a trading strategy was developed.
When you look at the asset's price chart, you may start to notice a pattern during that the chart is drawing. These movements reoccur in a very similar way, which makes them very recognizable and that earned them different names, depending on the pattern itself. Here are some that you might want to be on the lookout for:
- Head and shoulders pattern — it resembles a baseline with three peaks, with the middle one being the highest, thus resembling a head and shoulders. It predicts a bullish-to-bearish trend reversal
- Triangle pattern — This pattern is depicted by drawing trendlines along the converging price range. It indicates a pause in the currently prevailing trend.
- Flag pattern — This pattern takes place in a relatively short time frame, and it moves counter to the current price trend observed in a longer time frame. It was named like this because it reminds the viewer of a flag on a flagpole, and it indicates the potential continuation of the previous trend.
2) Learn to recognize a trade trigger
A trade trigger is another thing that you need to watch out for. It comes after all of the conditions are met, and it gives you a signal that the time for you to get involved is now.
Basically, when you start noticing that your conditions are being met, you wait for all of them to light up. At that point, you know that trade is possible, but it is still not the right time to get involved. Once the trade trigger — an event that comes after the setup, and lets you know that it is time to enter the trade — happens, you can react.
Handling things this way is very convenient, as you no longer have to question your every move and try to identify conditions that are met manually, or think whether or not it is time to enter the trade. It is significantly easier to set up such rules and a trigger and let the market's own development tell you when to make your move.
When you use a combination of different strategies and ideas into a single, major strategy, this is called a confluence. However, this same term is used for using multiple technical indicators for the purpose of deciding when to make a move. So, if you use several of the previously discussed technical indicators to create a trade setup, that is confluence. When these indicators are met, you get a trade trigger, which, as mentioned, signals that it is time to enter or exit the trade.
As mentioned previously, you may want to use several indicators just to be sure, and wait for a simple moving average crossover, a trendline bounce, and a specific pattern setup, if there is one to be found. You can use a different combination, depending on which one(s) makes you comfortable.
3) Comparing the risk and reward
This leads us to the next step, which is deciding whether or not to take the trade. First, you have defined your conditions and created a setup. Next, you define when you are supposed to enter by setting up a trade trigger. Finally, you need to determine if you should take the trade or not, by assessing potential risks and rewards.
Basically, if the reward — based on the setup — is greater than potential risks, you should execute the trade as soon as the trade trigger occurs. If the reward is not greater than the risk, you should let the opportunity pass and look for another one.
Another thing that should be mentioned here is the Risk/Reward ratio. As explained, this is a way to measure whether or not the reward is worth the risk. Many investors, therefore, use a risk/reward ratio to compare the expected returns on their investment, with the amount of risk that they must undertake while taking the trade.
To put this into perspective, let's say that you have a risk/reward ratio of 1:7. This means that you are willing to risk $1 and earn $7 if your trade ends up being successful. This would be a worthy trade. On the other hand, if the risk/reward ratio is 1:1, then this is not a situation that you should get involved in, as it is simply not worth risking your investment. Whether or not the ratio is to your liking is for you to decide, but keep in mind that the larget the investment, the more you stand to lose if the trade goes poorly.
In other words, you should pick your battles carefully, and in order to do so, you should be aware of company-specific or economic events, as they can influence your decision significantly.
Such economic events can be found in online calendars, such as DailyFX, as they are of major importance for the traders and investors worldwide. These events are listed in calendars by time zone, so anyone can follow them and plan their trades accordingly. Experienced traders can even assume the price movements depending on past price performances during similar events, so they know when to trade or not to trade.
Such events can have a serious impact on the market, as they often lead to spikes in volume or the price of some company's shares.
There are nuances to be worked out here, as well, but with some experience behind you, you will be able to predict the market's reaction to such news and events and know when to take the trade and when to withdraw. Playing it smart is always better than taking unnecessary risks when the reward is not worth it, and your chances of losing money are strong.
4) Use technical analysis
While we are at the topic of awareness of various economic events, many day traders tend to use technical analysis, charts, and alike, to try and come up with a strategy. As mentioned earlier, it can be difficult to determine when to interfere and when to let the opportunity slide, mostly due to lots of different indicators that tend to fill your charts and confuse you, have you second-guess your decisions.
This is a wrong approach that will have you hesitate and miss a good opportunity. It is better to focus on one strategy, like the one described above. However, you should also keep in mind that no strategy works all the time, and sometimes, you should change your approach.
Remember that your goal is to find low-risk, high-reward trades throughout the day. Some traders can even use a failure of one trade as an opportunity to set up another trade — one that will have a bigger chance of being successful.
The first step here would be to identify a good strategy, such as choosing a few technical indicators. Maybe start following a moving average crossover strategy, in addition to one or two others, for additional safety. As explained earlier, this is done by tracking two different moving average on a price movement of the asset that you are interested in. If the short-term moving average goes above the long-term one, that is an indication of an upward price trend, and it is a signal to buy. If the opposite happens, it is a signal to sell. Combine this with two other technical indicators and when these come together in an area of confluence, then look to make the trade.
In order for all of this to happen, the trade is likely to be fairly big. A lot of such developments may happen when major events are taking place, so you may want to observe event calendars mentioned earlier plan your trades according to the events.
5) Plan an exit
One last thing to remember is that you should also plan an exit by using the available information regarding assets' performance in the recent past. This is useful as it allows you to predict and establish a reasonable price target. This is easiest to do via charts, which will allow you to monitor the price performance and notice potential patterns.
You can then calculate the average recent price swings, and create a target of your own. Of course, you should also do the research and check out potential events that may have triggered price growth or drop in the past several days, in order to understand why the price moved the way it did.
A risk/reward ratio also comes in handy here, as it will make you aware of the risks and potential for profit, and indicate delicate trades which you need to treat with more care and attention.
It is also advisable to use stop-losses as a safety net, and instruct your broker to buy or sell once the asset reaches a certain price. That way, you can limit your losses to an extent, depending on how confident you feel regarding the trade. You should take minor fluctuations into account and not flee as soon as the price starts moving, but you need to be careful not to mistake a small fluctuation for a major drop that is only starting.
Stop-losses are very beneficial during a trend following strategy, as they can protect your profits better than anything else in certain situations. However, risk management is also an extremely important aspect of trading, and it revolves around the process of identifying, analyzing, and either accepting or avoiding uncertainty in your investment decisions. Simply put, risk management takes place when you attempt to calculate the potential for losses in an investment, and then take the appropriate action based on those calculations.
Lastly, once you decide on the target, and you reach it, that's the time to exit the trade, regardless of how the price is moving from thereon. This is the way to play it safe, anything other than that would be taking a risk that may or may not pay off.
Remember everything mentioned above, and research and use market conditions, create a good, strong trade setup, and use the tools at your disposal to perform market analysis. We know that it sounds like a lot, but trading is not easy, and successful trading requires time and effort. These things will become easier to do as you gather some experience and adapt to the market.
Until then, pay extra attention to risk management and risk/reward ratio, as this is what will help you earn the most money while preventing major losses of your investment.
Author: Ali Raza - A journalist, with experience in web journalism and marketing. Ali holds a master's degree in finance and writes extensively about the financial markets and fin-tech industries.