To be a successful day trader, you need to deal with the emotional ride that comes from rapidly changing markets, which relates directly to your profitability. You also need to be able to concentrate solely on the market, without distraction.
I work on a longer-term to short-term approach, starting with the daily charts to highlight key resistance and support levels that might affect my day trading. On the FTSE, for example, the market has being trying and failing to break the 200 SMA.
Figure 1 shows the 200 SMA has been seen as key resistance and support in the past, and this is likely to continue, especially as rallies towards this level coincide with sell signals on the Stochastic. Even though I am using the shorter times for my entry and exit points, having a wider understanding should help with profitability.
One of the most frustrating situations in a market driven by news flows is that the market can be overbought or oversold for extended periods in the short term (five and 15 minutes, for example). By moving between different timeframes, we can gain greater assurance as to whether the market is likely to continue moving in the same direction, or whether it might be due to undergo a sharp reversal. If we can see the market is extremely overbought across a variety of timeframes it will seem unlikely that the market will continue to rally. We can then wait for a sell trigger to start shorting the market.
It is personal preference as to which timeframe to use. I usually study the 5-, 15-, and 60-minute charts, the four-hourly and daily and perhaps the weekly. Knowledge gained from the longer times helps me find potential trading opportunities intraday.
Continuing with the example of the 200 SMA on the FTSE, we expect the market to find support or resistance at the 200 SMA. I can highlight it on my intraday graphs. If I start to see a change of trend at this level, I feel more confident in aggressively trading the move. In fact, after each of the pieces of positive news from the eurozone (concerning the Spanish bailout and the Greek elections) the market spike has tended towards the 200 SMA before reversing. If the market does not reverse there is a high chance of a fast move higher, because confidence builds after such a key indicator is broken.
Since we cannot rely only on such clear trades, I generally set up my short-term graphs as shown in figures 2 and 3.
Even though I use the MACD on longer term graphs, to initiate daily trades I tend to look mainly for the RSI and Stochastic to both be overbought or oversold, coupled with certain candlestick patterns. I generally also have an hourly graph on my screen, and wait for overbought readings across the timeframes to open a trade. The 5- and 15-minute graphs show that using the two in unison produced more profitable trading signals than did one alone. The graphs together show two clear trades, both of which are long. The signal forms when both timeframes are oversold on both the RSI and the Stochastic. A candlestick pattern is a trigger to open the trade.
After sharp moves in your favour, you can be tempted to take early profits, especially after impulse moves. I would not usually close out a trade until I had the complete reverse signal, but in news-led conditions I’m more inclined to move stops to lock in profits using the candlestick patterns from the longest-timeframe graph (generally hourly). I then close any trades with the end of the market. It is simply not worth the increased risk to leave trades open overnight, when anything could happen.
Clearly, news flow from the eurozone will become more important to trading any timeframe. The worse the situation becomes, and the less able the central banks and IMF become to help economies, the sharper will be downward moves and the slower any recovery rallies will be. I would not be surprised to see a fall similar to the move between 2007 and 2009, when market price halved. I don’t believe that the move lower will be as brutal as was the move we experienced at the start of the current global banking crisis.
A good way to think about all this is to note that the emotions of a trader can be comparable to those of a football supporter. A couple of good games (or very successful trades) and your side are world-beaters; then again, one bad result and suddenly everyone’s down in the dumps, the players aren’t fit to wear the shirt and the manager is a hapless idiot.
The more matches you play, or trades in the market you make, the more likely you it would be to understand these feelings. If you have a string of losing trades, the attraction of changing your trading system and possibly increase your risk can become greater, even to the point of trying to recover all your losses on one major trade.
The effects of psychology can prove very costly. However, the more you understand about what is driving the market and the greater familiarity you have with volatility, the easier it becomes to concentrate on profitable trading rather than being carried away by emotional swings.
Sharp market moves are driven, generally, by the news. In normal market conditions, there is a corporate and economic diary to remind us of market-moving announcements such as interest-rate decisions or US nonfarm payrolls, and that warn us to position our portfolio accordingly. But at present in Europe there can be market-moving news at any time. Speculation about bailouts or credit downgrades is rife, and business-page news can make the market move wildly.
The old adage, ‘buy on the rumour, sell on the fact’ has never been so important. For example, as news of the Spanish bailout hit the markets on 11 June, the FTSE was nearly 100 points higher in the first hour, but the market closed slightly lower on the day. In the United States, the Dow was also nearly 100 points higher in early trading before closing the session around 150 points lower. The swings were not so extreme after the Greek elections, but early bullishness was quickly lost as the trading session went on.
It seems worse for the US markets, concerned not only with the eurozone, but also with their own economy. The attitude seems to be, ‘if the economic data are bad, we are more likely to have another bailout’, so poor data are not necessarily negative. This attitude further increases the chance of sharp and unpredictable moves. For those confident enough to trade these markets, there are fast profits to be made. But does fortune always favour the brave? And how do we trade in these uncertain times?
No matter what investment period you choose, the building blocks of trading remain the same: concentrate on risk versus reward, money management and sticking to a trading strategy. The shorter the trading period, the more signals produced and therefore the more trades you place. By placing more trades, you expose yourself to greater trading costs, as well as to the possibility of a string of losing trades, which increases the risk of a rapid drawdown on your trading funds.
Steven Mayne is Managing Director of EGR Broking. He specialises in advising private individuals on short-term moves in the market, concentrating his research on the UK and United States. For more information go to: www.egrbroking.co.uk.
This article is an edited version of a feature originally on Your Trading Edge magazine. Subscribe to YourTradingEdge Magazine UK now and receive FREE the all new fully updated 3rd edition of 'The Naked Trader' (RRP £12.99) plus 2 years of YourTradingEdge UK Magazine’s timeless educational articles to help you profit from the financial markets. That’s 12 bi-monthly issues! and The Naked Trader for just £47.50. Simply visit: www.YourTradingEdge.co.uk/subscribe.
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Warning: Remember, particularly if you are new to trading in the stock market and in forex, that the prices of shares and other investments can fall fast and you may not get back the money you originally invested. The material here is for general information only and is not intended to be relied upon for individual investment decisions. Take independent advice before making such decisions. Also, the BullBearings free stock exchange simulation portfolios are a good way to practice trading techniques.