14.2 Basics of short-term trading

Hanumant Dhokle

It is difficult to pin-point certain strategies exclusively for short-term trading. However, since the time frame for an investment is very less, it is important to be very careful if you venture into short-term trading. Several basic concepts must be understood and mastered for successful short-term trading. These fundamentals can mean the difference between a loss and a profitable trade. Let’s take a look at these vital principles.

Entry Strategy

Certain stocks are ideal candidates for day trading. A typical day trader looks for two things in a stock: liquidity and volatility. Liquidity allows you to enter and exit a stock at a good price. Volatility is simply a measure of the expected daily price range - the range in which a day trader operates. More volatility means greater profit or loss for many day traders.

Spotting It Right

Generally investors get caught up in the moment and believe that if they watch the evening news and read the financial pages they will be on top of what’s happening in the markets. The truth is, by the time we hear about it, the markets are already reacting. So, some basic steps must be followed to find the right trades at the right times.

Watch The Moving Averages

A moving average is the average price of a stock over a specific period of time. The most common time frames are 15, 20, 30, 50, 100 and 200 days. The overall idea is to show whether a stock is trending upward or downward. Generally, a good candidate will have an increasing moving average that is sloping upward. If you are looking for a good stock, you want to find an area where the moving average is flattening out or declining.

Read the Market Trends

Especially in short-term trading, the key for decision-making is the trend. So carefully watch the trends since in short-term trading, it may be difficult to watch the fundamentals.

Controlling Risk

Controlling risk is one of the most important aspects of trading successfully. Short-term trading involves risk and so it is essential to minimize risk and maximize return. This requires the use of stop losses as protection from marketing reversals. A sell stop is a sell order to sell a stock once it reaches a predetermined price. Once this price is reached, it becomes an order to sell at the market price. A buy stop is the opposite. It is used in a short-term trade when the stock reaches to a particular price and it becomes a buy order.

Depend More On Technicals

Understand and remember that everything we know about is also known by others. So there may not be that information edge for you to make profit where others do not. To stay ahead we need to use technical analysis to understand what is going on.

Buy And Sell Indicators:

Though we need to analyze different chart patterns, and depend on resistance and support levels, it is very important to watch the trend reversals on a continuous basis if you are a short-term trader.

Patterns:

As discussed in the chapter on technical analysis, a pattern is a change in direction up or down in the price of stock and reflects changing expectations.

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