Day trading for a living shouldn’t necessarily mean setting difficult rules and using sophisticated day trading software and complicated indicators based on technical analysis. Although speed is quite important in day trading, price action and basic elements of technical analysis such as support and resistance levels and trend lines are effective enough to make money by day trading stocks. Day trading strategies can be devised from common online trading strategies, like simple swing strategies for stock trading. Yet, risk management is equally important and technical analysis can also help when a stop loss order should be placed.
Day Trading Rule: Use Support and Resistance
When we study about technical analysis in general, the first patterns we learn about are support and resistance levels. Those levels can be used in day trading stocks as well, although day traders need to identify them quickly enough to enter the market in a timely manner. Here is the STP 5-min chart about 30 minutes before the close of the market, including the price fluctuations of the previous day.
Notice the support level at $0.83. STP stock price first found support there at 12:15. There were two confirmations of the support level 3 hours later, when price was rejected immediately, as the long shadows of the candlesticks indicate. Buying at $0.83 would obviously be ideal, but we might miss the entry if the price fails to retest the support level for a couple of ticks. Therefore, buying at 0.85 would be more likely. The support level will be used to set the stop loss order exactly below it ($0.82). I suppose there are not a lot of day traders who would predict a decline at this point, despite the fact that we need those traders to actually buy shares from! Let’s see what happened during the last half hour of trading.
STP stock price skyrocketed and closed at $1.00! If day traders bought 10,000 shares for $0.85, they would have made a ton of money. In fact, the profit of this day trade would be $1,500 while total risk would have been $300 given the stop loss I mentioned; that is a trade of 5-to-1 reward-risk ratio that lasted less than an hour! Also note the dramatic increase of volume in the last 15 minutes of trading.
Resistance levels can be used in day trading in the same manner. Here is the 5-min chart of SWKS.
Two and half hours before the closing bell SWKS stock was trading at about $21. The most easily recognized resistance level can be spotted at $21.25. Yet, $21 is a round number and buyers seem unable to push the price above that level. I would obviously be looking to short sell the SWKS stock at that moment and my stop loss would be set either above $21.25 or just a couple of cents above $21. A tight stop loss often improves the reward-risk ratio of a day trade, but we can be stopped out just as often! What would happen if SWKS had been one of my day trading stocks of last Friday?
The downtrend continued and SWKS stock price declined to $20.
In the next post we’ll discuss about another simple rule of day trading stocks called momentum trading.