Stock markets are all about buying and selling but not all trading is the same. While it is about the purchase and sale of stocks, the actual form of trading can vary. There are traders specialising in buying and holding stocks for months and years together. Others still hold them for a few days or weeks. But there is also the form of trading that holds stocks for the shortest duration possible, that is, during the course of one day. This is, in simple terms, day trading.
So, how is the selection process of stocks different for day trading as compared to the longer duration forms of trading? As a trader looking to earn profits, how does one go about choosing stocks for day trading?
What Is Day Trading?
Day trading involves buying or selling stocks and settling the open positions before the end of the same day’s trading. This, typically, involves multiple trades and a day trader makes many and frequent purchases and sales during a day.
A day trader attempts to exploit the movements in the price of a stock over the course of that one day. His knowledge levels of the market conditions and skill in reading the possible variations in its intraday price help him in the decision to buy and sell. It is from these multiple trades that he aims to make a profit.
The Opportunities And Risks In Day Trading
To help make the most of these intraday trades, a day trader relies on a wealth of data and information on the trends in the price movements in the past. With the support of technology and algorithms, it is possible to make more informed decisions. There is the constant news and updates that trickle in all day long that facilitate taking spot decisions to enter and exit positions to maximise profits and minimise risk.
While the opportunities are aplenty and an experienced trader can, theoretically, make handsome profits from his trades, day trading can also be fraught with uncertainty and risks. The markets can get volatile and unpredictable anytime and the best of positions can suddenly get toppled.
The Importance Of Choosing The Right Stocks
The crux of any trading lies in choosing the right stocks and all success lies around the selection of the right ingredients for a portfolio. Of course, it is just as important to get the timing of the purchase and the sale right but it all begins with the decision on what stock to buy or sell.
This is, usually, a combination of the experience that a trader has, the knowledge that he possesses and his mental preparedness. But whatever the seniority and skill of the trader, the following tips still hold for anyone looking to choose stocks for intraday trading.
Assess Your Situation
Every trader has his own trading goals and his pool of resources that make him different from other traders. Whether it is the access to working capital, experience in the business, knowledge levels or the material he is working with, this varies across traders.
Assess your own situation and be aware of what your goals, your strategies and your resources are. What you are as a trader and how you function will have to be considered when choosing your stocks too.
Liquidity Of Stocks
A big consideration during stock selection in short term trading is the liquidity level of a stock. Understandably, when the window of an open position is small, it is important that you are able to close it out easily and quickly. Unless a stock is fast-moving, it may not be possible to find a buyer when needed.
Stocks that are liquid find takers even in large numbers with minimal adverse impact on the price. Those that have high turnover consistently are the ideal picks in intraday trading
Read Also: Day Trading Tips for Beginners
While we talk about the factor of liquidity - stocks that are natural picks for intraday trading show a tendency to be fluid in terms of price movement. But it need not mean that any share that shows volatility is ideal for short term trading. There has to be an optimal movement in prices as stagnant stocks are illiquid and extreme fluctuations can be tricky to handle.
So, the ideal stock for intraday trading must be one that has an inherent movement in prices but in a controlled manner. Usually, any stock that has a variance of 3% or above can be a candidate for the job. Also, in actual dollar terms, those that move greater than $1.50 also are ideal for consideration.
Research trends and technicals
All investing and trading are about being updated on fundamental and technical analysis, studying price movements, market trends and patterns. This, especially, holds true for day trading where there is more focus on technical analysis than on fundamentals. After all, the holding is only intraday and any changes that require more than a day are irrelevant.
So, the data and information that is useful for choosing stocks for day trading have to be more specific. Here are the tools that are more suited for this requirement.
Trading volumes: This list has the stocks that get traded the most on a given day. A historical chart of this data can give good pointers on the ones that offer the best liquidity.
Weekly movement: Another list that can be helpful is a weekly round-up of the movement of each stock. The ones that close higher and lower can help choose those that have been performing better, of late.
Resistance and support levels: To understand the levels at which stocks face resistance and support is a good chart to base your selection on. This gives a heads-up on which ones show indications of gaining and losing.
Best performers: This tells you the top gainers and losers in the recent past and can be a good reference point of what to expect from them in the near future.
Stocks to watch out for: Then, there are the stocks that keep coming up in the news for both good and bad reasons. It gets easier to keep a lookout for them as the market is bound to react to any development concerning them.
Price Consistency And Correlation With Market Indices
A safe yet smart way of choosing stocks for day trading is to pick one whose movement is usually aligned with that of the sector itself. Even stocks that have a correlation with the indices can be a logical way of approaching selection. There is a lesser risk of an individual, disconnected performance that can be more haphazard and unpredictable.
Working with stocks that behave in tandem with the indices or even those that mimic the sectoral movement gives a sense of predictability and fewer shocks. Also, the best and worst-performing companies or the top gainers and top losers promise a better chance at exploiting their price movements. When working with multiple stocks, it can get difficult for a trader to keep a tab on a random one.
Stay Away From Obscure Stocks
When buying a stock for a longer holding period, it is possible to take chances with a lesser-known company. This is what investors typically do by picking up shares of companies that may be promising but not proven yet. Small and midcaps fall in this category and could even turn out to be a hidden gem and, therefore, a good haul in the long run.
But a day trader does not have the luxury of choosing a lesser-known company, given the tight and tiny window he has. He will have to rely on the liquidity factor much more and look to shares that can give him the smallest but surest upside the same day.
It is always better, especially for new traders, to stick to sectors that they are familiar with. Also, it is advisable, initially, to trade in stocks they fully understand and follow. While on new traders, it is just as important to trade in a limited number of stocks as it is to be cautious about the selection itself.
Check Out The Trade Volume Index
An important indicator that is widely used in day trading is the Trade Volume Index. This shares information on the volume of trading done for a certain asset. It is a measure of the volumes, frequency and the amount of funds involved in the trading of a stock on a given day.
The higher the volumes, the more the likelihood of a stock attracting interest for both the right and wrong reasons. For instance, a sudden increase in the volumes could point to volatility in the price levels. This is something that intraday traders should monitor closely.
Specific Sector Approach
Then there are certain sectors that are market favourites for day trading. In particular, the financial sector with high profile banks like Citigroup, JP Morgan Chase and others have always been popular, given their easy liquidity, consistent profitability and healthy market capitalization. These stocks are also reputed for their ability to correlate with both the market and the sector indices.
Another sector that lends itself to day trading is the technology where the behemoths like Google, Facebook and the pack have led with their skyrocketing valuations and earnings. These also enjoy media attention and get mentioned often to stay adequately volatile and liquid. This adds to their getting widely traded and being a sought after segment for day trading.
Day trading can be quite a difficult part of the overall trading function with the brief window for holding a position and the speed at which trading has to be done. Here, choosing a stock is critical and, often, the reason why trades can turn out to be about gains or losses. But, with the right approach and practice, it still is possible to make sure you make all the right moves.
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