Day traders seek to gain profits from both the up and down sides of financial markets. Day traders who make a living buying stock, do so by following rules based trading strategies in order to maximize profit and minimize risk.
Trend Following
Trend following is a school of day trading that considers current market price, equity levels, and market volatility. This is based on a rules based trading system that determines the initial position size at the time of entry into the market as well as pre-programmed exit positions. Day traders who use trend following use moving averages, current market price calculations, and channel breakouts to determine which way the market is trending. Trend followers do not try to forecast future markets or prices, but simple ride the trend in an attempt to maximize profits when prices are high in order to minimize losses at low points in the trend.
Current market price is the main indicator of trend following as it determines how well a stock is performing at any specific point in time. One other factor that weighs heavily on a trend follower is the decision of how much to trade over the course of the trend. This plays largely into controlling risk as more shares equals more liquidity and profit but also has the potential for bigger losses. The trend follower always tries to cut losses in order to save capital.
Contrarian Investing
Unlike trend followers, contrarian investors seek to do the opposite of what a majority of investors are doing. They target highs and lows in a trend as specific buy or sell points. The mantra of a contrarian is to "Buy low, sell high." The rules of crowd behavior play a large part in contrarian investing. Often day traders use market volatility indexes or "fear" indexes to determine when the time is appropriate for market entry. The practice often involves buying stocks when investor pessimism is high and therefore stock prices are low. Conversely, optimism in the market can lead to an overpricing of stocks.
An example of contrarian investing are the Dogs of the Dow, companies who are experiencing lows in investor optimism for a variety of reasons. Dog investing involves buy large volumes of shares in these companies, in an anticipation of another upward trending cycle.
Other Day Trading Strategies
Day traders utilize a variety of different other techniques in order to maximize profit. These include scalping, rebate trading, and range trading.
Scalping exploits the small moves in a stock's price as it either trends upwards or downwards. The key is to make quick small moves. Scalping does not involve buying large volumes of stock, but focuses on a variety targeted, small buys, thus exploiting the market's volatility. Scalpers use many concepts of technical analysis like reading support and resistance zones in order to determine market volatility.
Rebate traders specialize in low priced, high volume share purchasing that allows for the more liquidity with set capital. This creates versatility and minimizes potential losses as well as maximizing potential profit. Rebate trading is based largely in equities.
Range trading utilizes support and resistance levels in the market. When a stock rises to a certain resistance level its price will fall back down to a certain support. Range traders look for these price ranges and buy stocks at the support level while selling them when the stock meets a resistance level. Unlike trends, these stocks are traded within a specified high-low range. Like scalping this method allows for quick, small moves that over time will gradually earn profit.
These day trading strategies are frequently employed by successful traders. Each school has its benefits and relies on its own theories of how the market operates. Some try to profit on investor behavior while others look to the trend exclusively.
Sources:
Brown, Kedrick (2006). Trend Trading: Timing Market Tides. John Wiley & Sons, Inc.. ISBN 0-471-98021-8.
Tate, Christopher (March 2001). The Art of Trading. ISBN 1 876627 63 8.
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