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My Guide to Day Trading v1.0

Discussion in 'Trading/Investing Resources' started by Arturius, Dec 10, 2007.

  1. Arturius

    Arturius

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    Introduction

    Everyone has heard of it, everyone has been warned about it, and everyone feels reluctantly curious as to the daily life of a successful Day Trader. The thought of making quick, fast, and ‘easy’ money from home by reading the markets is strongly appealing. So appealing, in fact, many people use this as the basis in arguing that can’t be profitable. The expression “if it’s too good to be true, it probably is” is a cliché that guides our life choices. We’d rather risk missing out on a large opportunity then look like suckers. Luckily in day trading, there’s a time-proven method of avoiding becoming just another ‘sucker’. Developing a fundamental understand of the market, creating a system that matches this system, trading within its rules, and using sound money management to ensure this works into the distant future. A combination of aptitude, hard work, discipline, and strict capital management are the key ingredients to a successful Day Trader.

    I’ve heard it’s impossible to be profitable Day Trading. Who is right?

    This is a common argument against Day Trading – it’s impossible to make a profit because the market is efficient, and even if it wasn’t, you’re competing against people who are much smarter then you. Some, however, should be heeding the advice, as the skill set and mental attitude they possess is not high enough to be able to trade profitably. Just because something is extremely difficult, and takes a huge degree of understanding, doesn’t mean Day Trading is some sort of scam. Although it may be advertised like a scam, it’s really no different to poker. Poker promises great riches to the talented player prepared to take risks. If you think about how a layman views and rationalises poker, and ask them for how they ‘beat’ the game, you’ll hear baseless theory, often built on results orientated finds from anecdotal experience. Day Trading is no different; the theory and skill gap between the top traders and the rest is startling (but not unexpected).

    The myth that Day Trading can’t be profitable is one which usually leads back to the gospel perpetuated by academics. Academics have a vested interest in keeping Day Trading as a ‘gambling’ venture, theoretically unprofitable; most economic and financial models are based on theories which were written under the assumption that the market is ‘perfectly efficient’. They have half a point, but it’s not the full story. A better way to think of the markets is them being ‘effective’ rather then ‘efficient’. The price rarely ever sits at its mean, its rational value, all factors considering. Instead, it’s like a rubber band, which bounces around the mean like a pinball. Much like a rubber band, the further price moves away from its true mean (or value), tension grows, and using certain systems we can devise the strength of that tension, and what the short or long term expectancy is for that price.

    This is of course, my opinion. You’re entitled to your own. What I do ask, is instead of pointing fingers using second hand evidence, take a step back and look at the whole picture. Read both sides; think about the rationality each exhibit. If you’re convinced of a side of thinking, stick to it. Buy and hold is a viable strategy, not the strategy I would choose, but some great thinkers have turned it into great money, so I respect that. At the same time, there are undoubtedly traders that have turned great fortunes using a different strategy, but still with the idea of exploiting pricing differences. Day Traders, Market Makers, Swing Traders, Arbitragers, Value Buyers, there’s a rich guy behind every level.

    Is our job as a Day Trader to predict the market?

    NO! Prediction is for CNBC analysts and ivory tower banking macro economic think tanks. Seldom is either on target and even if they were, the advice they give is to obscure and based on too many variables to be profited off in a realistic sense. The goal of an astute Day Trader is to develop theories about his chosen market(s) through observation and testing, and using risk managements strategies, in order to show a long term profit. This is not prediction. We’re exploiting statistics in order to create a competitive advantage in the market place.

    How does one profit from Day Trading?

    By constructing two facets; build a dynamic system, and tailoring a risk strategy to that system. A risk strategy is using your capital, or ‘bankroll’, and optimally allocating it for each trade you make. Obviously, risking too much on a single trade can be disastrous, and increases our risk of ruin. Allocate too little, and we may see sub optimal profits. A balance must be struck. TraderMike has a fantastic article on the types of position allocation and the conventional thinking among traders:

     
  2. Arturius

    Arturius

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    How does one go about designing a system?

    This is the million dollar question, no pun intended. To develop a winning system is worth its weight in gold, for obvious reasons. First, it’s important you tailor a system suited to your personality. Here are some possible dimensions for your system:

    · Time frame (this article examines day trading, but some of you might be suited for longer trading time frames, so I’ll go in to it later).

    · Mechanical or discretionary

    · Trend-following (also referred to as ‘momentum trading’), or bracket trading

    · Security type (index future, commodity, or shares)

    · Risk vs. Reward (high percentage of small winners vs. small percentage of large winners)

    All of these dimensions must be considered at some stage within the context of your risk tolerance and personality. The biggest pitfall I see amongst poker players when they begin trading is the lack of patience. Most successful poker players own the game by dominating it, attacking other competitors, and changing the games style to suit them. This strategy is the fastest way to get wiped out. The market will move regardless of what you think of it. Your stubborn trading of 5 e-mini’s is completely irrelevant, a drop in the ocean. Your interpretation of the market can’t force it to reconsider its position. In poker, when a player is weak, we can raise them, forcing them to fold, and us to win the pot. In trading, even if you know the market is structurally weak and due for a fall, aggressively trading it isn’t going to cause a collapse. The market can remain structurally weak longer than you can stay solvent, believe me. This is why its important to identify a system based on percentages rather then intuition. Irrationality regularly shadows the market, and the trader who refuses to believe this is the trader who now owns a lighter wallet.

    The first step is to read, read, and then read some more. On the bottom I’ve picked out my favorite books on trading. Buying a few at a time, reading, and trying to develop a theory or understanding of the market is essential to building a system. People don’t sell winning systems pre-packages, and even if they did, markets change and systems become obsolete, forcing its user to tweak inputs. If you don’t understand the system you’re trading, you’ll get wiped out. It’s not an if, it’s a when. The year 1999 was a major boon for technical traders, using simple stock momentum systems to make a boat load of money. During the tech boom, traders used to exploit the pile on effect for tech stocks. Statistical models supported this; during this time, a price jump in a stock almost always incurred a follow through of 5 or more cents. This may sound insignificant, but when you’re heavily leveraged, the effect happens a high percentage of the time, and you only need to hold the position for a minute too scoop a profit, the system only need be performed several times a day to make a handsome living for its trader. Then the dot com’s went bust, and like magic, the system didn’t work anymore. Many traders went broke, protesting that it was somehow the markets fault. Some even had the audacity to blame newly design quantitative and hedge funds, saying they scoop too many profits away, creating ‘too efficient a market’. Truth is, they never understood their system, thus couldn’t make the needed modification to keep themselves solvent. Learn from their mistakes; always be examining new theories and ideas in the pursuit of the truth.

    One of my favorite ways to find new ideas is just to read all the news headlines and blogs. I’ve included some of my favorite reads down the bottom. The key is, always be thinking about everything within the context of the market. Experts distort the truth. Like a power game, no one wants to reveal their true position. Everything is a smoke screen. This abstract thinking can help inspire you to test new ideas and new theories, which is the key to developing a winning system. It doesn’t happen overnight, but the long, arduous journey is as much fun as it is profitable.

    What do you mean by time frames? How does this apply to a Day Trader?


    I’m going to steal some of James Dalton’s ideas on time frames, mostly because his seem to fit nicely, and from anecdotal experience, it seems to hold true. Five time frames exist, grey areas obviously exist, but I find it’s a good starting point when dissecting the charts. Scalper, Day Trader, Short-Term Traders, Intermediate Traders, and Long-term Traders are the five main divisions.

    Scalper

    The scalper lives by the minute hand, continually buying and selling in order to take advantage of fleeting discrepancies in order flow. Scalpers may make as many as several hundred trades a day, comprising thousands of contracts. Scalpers rely on intuition. They buy and sell from all timeframes, and their ability to respond to the immediate needs of the marketplace provides essential liquidity. This timeframe is utterly detached from longer-term economic trends, for obvious reasons. For these guys, its all about reading order flow.

    Day Trader

    The day trader enters the market with no position and goes home the same way. Day traders process news announcements, reflect on technical analysis, and read order flow in order to make trading decisions. They also have to deal with the other timeframes buying and selling, margins calls, major economic news, even seemingly harmless speeches by Fed insiders (hello Greenspan effect!). Anyone who believes the markets are rational should spend a day trying to digest and react to the landslide on conflicting data day traders must wade through to make a decision.

    Short-Term Traders

    Short-term traders often hold trades longer than a day, but usually not longer than three to five days (a trading week). Short-term traders usually have to be much more aware of economic trends, and monitoring important junctions that exist, such as trend lines, new highs and lows, etc. They’re always on the look out for break outs, either to fade (which means to bet against the movement continuing), or get on board the momentum.

    Intermediate Traders (or investors?)

    The difference between intermediate traders and short-term traders is simply they operate on a longer term view. Rather then thinking of a set timeframe, Intermediate Traders (often referred to colloquially as “swing traders”) are usually more focused on the time the market spending bracketing, rather then an actual set time piece of a month or 3 months. They usually attempt to buy at the bottom of a bracketing market, hoping to sell at the top, or vice versa. They may also, like the other timeframes, pile aboard powerful break outs or short when the market tanks. Swing traders usually process a lot more fundamental information then both Short-Term and Day Traders, because the sheer amount of different technical ideas can make it difficult to judge which is important in the context.

    Long-Term Investors

    Long-term investors are far more attached to the securities they own. They have a stronger tendency to buy securities and put them away for some time, with holding periods from months up to several years. When they are active, they deal with very large positions that are very visible to all participants in the market. Shorter term participants that wish to stay solvent understand to either get on board or move out of the way when the long-term investors decide to take a position.

    Note that when you see a major, powerful move in the markets or a stock, its almost always all the timeframes moving in unison. Like the food chain, the longer timeframe is the dominate force over the smaller one, taking on an alpha like role. Short-term traders, no matter how stubborn, will always get run over by the long-term investors, through the sheer weight of the contracts/stock quantity they use when entering the market.

    What kind of money can someone make?

    This is completely dependent on your capital, your margin, your trading style, and how powerful your system is. There is no real way to answer this question, but when it comes to futures, I’ll give you an example.

    A Dow Jones Industrial E-mini is worth $5 per tick. A tick is the minimum movement a security can make. For a stock, it might be $0.01. For futures indexes, it’s usually a point. If I’m going long (i.e., buying contracts with the intention on selling them for a higher price) with 10 contracts of E-mini’s. If I make a profit of 20 points (that’s the same 20 points you’ll see on a quote of any index, for example, holding this position from the DJIA from 13450 to 13470), the math is simple:

    $5 x 10 contracts x 20 points = $1000 profit.

    Of course, your trade could go the other way, netting you a loss of the same magnitude. Using this and the expectancy article I posted, you should be able to deduce profits you can make depending on your bankroll.
     
  3. Arturius

    Arturius

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    What’s the best method for obtaining charts? What broker should I use?

    There are many charting platforms around; all vary in complexity, power and cost. Personally, I prefer to go for something that’s overkill for my problem. It seems to inspire me to experiment and push the boundary. Here’s a list of charting platforms:

    * E-Signal
    * TradeStation
    * Metastock
    * Qtstalker
    * CQG
    * Sierra Chart

    One feature of a dedicated charting program is access to a real time feed and downloadable past history for back testing. All of these software companies have a huge database of past data for a trader to tap, and can be requested at any time using the system. The two most popular from my observations is E-Signal and TradeStation.

    Another program you may need is an execution platform. Each comes with their own interface and broker compatibility options. Brokers usually support multiple options, such as Zen-fire, OpenTick and IQFeed. Talk to your broker about which their preferred execution system is, as each as a different opinion about which has the fastest quote and trade execution delivery. A List:

    * FXTradeStream - Takes signals from emails and executes them in the MetaTrader platform.
    * HyperOrder - Takes signals from TradeStation, MetaStock, ESignal or a custom application and sends them to a broker's API including FXCM, EFX Group, MetaTrader, Interactive Brokers and more.
    * Neoticker - Create automated systems and execute them into MB Trading, EFX Group, Interactive Brokers or FXCM
    * NinjaTrader - Sends signals from TradeStation, ESignal or a custom application into Interactive Brokers, MB Trading or Gain Capital
    * SnapDragon - Sends signals from TradeStation to Oanda's API
    * Thinking Stuff - Backtest and automate your trading system into Gain Capital and Oanda with the click of a mouse. No programming knowledge required.
    * Trade Bolt - Takes signals from TradeStation, ESignal, MetaStock or WealthBuilder and sends them to Interactive Brokers
    * TradeBullet - Sends orders from TradeStation, eSignal and custom applications into Interactive Brokers, EFX Group and MB Trading
    * TradeCompanion - Automates your trading systems written in TradeStation, Excel, Visual Basic or any other proprietary platform and executes them into the BGCFX trading platform.
    * TradeItself - Takes trading signals from emails and sends them to the FXCM Trading Station

    The two most popular from my observations is Neoticker and NinjaTrader.

    Next on the shopping list is deciding on a broker. This all depends on the market and instrument you wish to trade. It doesn’t make much sense to pay for services like being able to phone your broker to make trades, when you can cheaply use your internet platform to perform everything. That said, you want a broker reliable enough so in the event on an emergency, you still can make the call and close a position if necessary.

    There are many, many, brokers out there, so I’ll just talk about two that I’ve used and would highly recommend. Both have similar costs per contract(in the case of futures), but InteractiveBrokers offers share trading as well (at the lowest rate I could find). The third is Bell Direct, I have a friend who trades the Australian market using them and seems very happy with them. I, however, have no personal experience with them, so sign up at your own peril.

    * InteractiveBrokers
    * Mirus Futures
    * Bell Direct

    About E*Trade and other brokers… Stay away. Don’t even think about it. Their commissions are terrible, their execution platform sucks, and I don’t trust anyone who markets their site like that anyway. Stick to the guys that keep costs low, and know what you want; reliability and compatibility. Remember, this is in a Day Traders context. If you’re a buy and hold type trader, it’s a different story. We need every edge we can get, believe me.
     
  4. Arturius

    Arturius

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    What books should I buy?

    I like keeping a diversified bookcase, one with many different ideas and theories. I even read books who say its impossible for me to be profitable (‘A Random Walk Down Wall Street’). Thinking is the name of a game. If a book like Random Walk makes me question my beliefs, perhaps they’re not strong enough to consider risking money over. I read this book and picked up tones of logical fallacies, and even used it to think up new market beliefs. If you’ve read this book, PM me and I’ll pass along some of my thinking. Here’s a list of books with a short description. If you’re going to buy, be kind and use my Amazon affiliate links, because if I get about 10 of you guys clicking I can buy that super cookbook I always wanted :) :

    * Technical Analysis of the Financial Markets by John Murphy. The bible of technical analysis. Although its crude, and probably too simplistic to be worked into a real system, the break down on theory and the explanation of indicators is the best place to start for a beginner to learn the subtle hand of TA.

    * Technical Analysis Explained by Martin Pring. I love Pring’s writing style. His book is a lot like Murphy’s, but his analogies are fantastic. You could probably buy one or the other, though. Murphy has more content, Pring has a little more color in his writing.

    * Martin Pring on Market Momentum by Martin Pring. Understanding the effects of momentum (or lack thereof) on price is very key to understand the supply/demand relationship that exists. Although once again, its probably too simplistic to base a system on it alone, thinking about how two seemingly identical price charts can convey a different tone is the next step in the learning process.

    * Intermarket Analysis by John Murphy. This is another mind expansion book past the bible. It talks about the roles the bond markets, other markets, indexes, and commodity futures play in altering each others course. To emphasize how good this book is, I still overtly use its ideas in my trading today. Its moved me to decode the web of intermarket movement, and explore how I can improve the effectiveness of my system by looking at how other markets are reacting.

    * The New Market Wizards by Jack Schwager. This book is just about inspiration. It’s an interview with 10 or 12 ‘market wizards’, guys who run hedge firms, investment banks, mutual funds, and talk about how they became the top performers in their field. The stories are a fantastic read, even for a non-trader. It shows that every trader’s path is wildly different, and failure is inevitable in this business. Those with the true conviction and persistence shine through.

    * Trading Day by Day by Chick Goslin. I love Goslin, this book is little known but I love its message. Goslin takes us through his strangely simple system, and shows us how he uses basic indicators in conjunction to produce a winning system. Goslin talks about his trades in real time (I can confirm this), and his market thinking is so simple yet so effective. If anything, this proves you don’t need to be super human to trade; you just need to perfect your craft and trade with a positive expectancy. He’s the ultimate probability trader.

    * Trading in the Zone by Mark Douglas. Psychology will break you. You may think your tough, but trading is not like anything else in life. There’s no rules, no boundaries, unlimited freedom. All you’re doing is guessing price movements. And without this book breaking down my psychological inhibitions, I probably would never have been a profitable trader. It’s a book that humbles you, but at the same time, empowers you with the truth.

    * Way of the Turtle by Curtis Faith. The turtles are legendary, if you don’t know the story, read about it here. Faith tells his story like an autobiography, but relates it to a trader’s journey, and the pitfalls one must avoid. He also explains his market beliefs, and why they remain profitable using a system expectancy system. His back testing ideas on how to avoid curve fitting is important, if that’s the type of thing you’re into. Also, being 19 years old and making $32 million dollars in 4 years, how is that not inspirational?

    * Trading Your Way to Financial Freedom by Van Tharp. This guy is the ultimate level headed trader. He’ll cool your hot headed ways, and show you how to mould yourself into a winning trader. His book was the basis for TraderMike’s expectancy article. Although most of this stuff is elementary for poker players, its still essential we consider risk of ruin in all system analysis. He also shows how multiple time frames and ideas can be profitable, and how loose thinking can bankrupt you easily. His writing is like that of an old sage, soothing, responsible, but not afraid to share wisdom.

    * Financial Freedom through Electronic Day Trading by Van Tharp. This book is outdated and covers a lot of what his other book does, but I still recommend it because it takes ideas from a different perspective, talking about the bid/ask, and making trading ideas a little more practical. It has ideas about avoiding big institutional moves against you, and this thinking is invaluable for any system.

    * Enhancing Trader Performance by Brett Steenbarger. A fantastic book for traders and non-traders like. This book talks about developing skills from a psychology perspective. Steenbarger is a professor and PhD holder, and he takes a different approach to exploring the mind of a top performer, whether it’s a trader, an athlete, or anyone in a performance based field. Personally, this book inspires me so much more then any generic self-help book. I think it’s a must buy, because he also talks about some great trading system ideas that you won’t find in many other places.

    * Freakonomics by Levitt and Dubner. Nothing to do with trading. But it shows the importance of thinking outside the box and never taking anything for granted. The reasons why events happen is not as simple as the headlines CNBC spouts every 30 minutes. Stocks don’t rise because of good earnings, or fall because of bad ones. Using Freakonomics logic, you can go behind the scenes and learn why moves really happen, and which ones can be traded profitably.

    These books should provide a good starting point. I’m sure more people will recommend more books on this thread, that’s fine, but I’d probably start here no matter what anyone else says. Next, I’ll list some blogs that I read. There are too many good ones to list, but this should be a great starting point for finding new ideas. Some of these guys are great traders, others are not. But it’s dissecting the thinking that counts.
     
  5. Arturius

    Arturius

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    * Alchemy of Trading - Market theories
    * Curtis Faith - Original Turtle
    * Deh Trader - Stock scalper
    * High Probability Trading - Advanced Futures Trading
    * - Alternative Ideas
    * Phileo - Chartist Commodity Scalper
    * The Big Picture - Market Overview * Recommended
    * Trader Feed - Trader Psychology * Recommended
    * Trader Gav - Misc Trading Thoughts
    * Trader Mike - Stock Watch and Moves * Recommended
    * Trader X - Candlestick and Fib Stock Trading
    * Trading Digest - Future scalping videos
    * Trembling Hand Trader - ASX Trader
    * Van Tharp’s Blog – Trader Theory * Recommended
    * Ugly Chart - Stock and Futures Watcher
    * Wall St Warrior - Stock Dummy Trader

    Feel free to ask any questions or make any comments. I’m sure there’s a lot of stuff I missed out. Hopefully people find this useful. I’m not suggesting day trading is right for you, but even if you don’t trade for money, sometimes its fun just to muse about the market and its random workings. There’s always something new to learn, new to analyse, and it’s ever humbling.
     
  6. Synergy

    Synergy

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    Looks great Arturius, just the sort of thing I'm after at the moment. The list of programs and books is great. Really is much appreciated. Reading for tomorrow :)
     
  7. Kauri

    Kauri E/W Learner

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    It is one of my goals in life to be able to post a missive only half the size of yours every minute... you have my amazed respect
    rather than Amazon and the other links which possibly feed back to you it may be a good idea to support the Forum and buy/enquire through that?? ASF Investment Shop
    All the best in your endeavours
    ..........Kauri
     
  8. Miner

    Miner

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    Dear Folks
    Where as the efforts to provide us an excellent lesson on day trading by Arturius is highly commendable I also support what Kauri said: to support ASF publications. After to be perfectly fair ASF created this platform for us disseminate information and learning and if we are making money there should be no free lunch.
    We also should promote our ASF at the same time.
    Well done Kauri and Arturius. I do not dare to write even a paragraph like you guys did so I would be in the side line with my mining shovel.

    Regards
     
  9. chops_a_must

    chops_a_must Printing My Own Money

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    Have you ever physically hurt anyone with your sharp tongue? You crack me up. :)
     
  10. Kauri

    Kauri E/W Learner

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    If I posted a link to the charting setup I use.. mind you only one link of potentially many..... I could afford to wear the sharp edge off on lamb bones.. :) Being a gratefull softie I'd rather it went to ASF... hence I don't post links to products...
    Cheers
    .........Kauri
     

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  11. Timmy

    Timmy white swans need love too

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    Thanks Arturius - a lot to read through here, will take me a while, thanks for posting it.
     
  12. >Apocalypto<

    >Apocalypto< 20.03.2012

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    I personally think the man you need to talk to about this topic is Trembling Hand hopfully he can make a contribution to this. Not forgeting Prof Frink & acouch as well.TH is a day trader, and full time, trades he SPI and the other Asian indexes, which from watching myself are a whole different ball game!! Wild Wild Wild! TH if my info on u is incorrect please let me know, i will have it changed.

    From my personal experience at trading intraday, I think the trader needs to have one system for entry exit and money management. he or she must never deviate follow the plan to the letter. (unless it's failing badly of course) Then screen time screen time and more screen time, really get to know your chosen market. look for patterns in it's behavior. start small and build your self up. last point emotional people, i don't think can last in intraday trading u need to be cool calm and relaxed.

    Like a ICEMAN
     
  13. coolcricket

    coolcricket

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    Thanks Arturius, a lot of info, very helpful.
     
  14. Arturius

    Arturius

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    I have no problems with people ordering their books through ASF, as a first choice. ASF obviously provides a much more costly backbone then I do, and those guys put way more time into education then I do, so its only fair to give something back.
     
  15. julius

    julius

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    it's strange how day-trading is portrayed as 'high risk' - even at the most fundamental level it is the exact opposite

    the risk comes from the LEVERAGE associated with day-trading and has nothing to do with the frequency of trades. over trading is hardly a disaster.

    imo longer term trades are subject to more risk
     
  16. Arturius

    Arturius

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    I think there's more of a skill risk though. Its easy to not understand the market, and lose trade after trade after trade. There's so many different types of market personalities on any given trading day, you can easily get caught trying to play rock every time its a paper market, getting frustrated, then the next day playing a scissor, only to find its a rock day. This risk is much different to a buy and hold long term position, because typically market weirdness averages out over the long run, so the more complex ideas you don't need to worry about.

    For a seasoned day traders, their risk is much lower then the long term traders, without a doubt.
     
  17. Trembling Hand

    Trembling Hand Can be found on the bid

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    The so call higher risk associated with day trading comes not from the risk to market exposure but from expectancy. If your 'system' has a negative expectancy and you are day trading you are going to blow up much quicker than a buy and hold system or even a swing trading system. I think many people judge their system on a small amount of trades in a bull market and think they have made it.

    As soon as they try day trading they blow up because the averages get to there ultimate result much quicker. They walk away with very burnt fingers thinking "boy that is too risky" when really if they had a system with positive expectancy after brokerage they soon see that as a day trader your risk is by the nature of being flat at the end of the day very low.

    It’s all about expectancy. I know a day trader that recently had huge growth in his account over a 6 week period and didn't have one down day. And he traded heaps with big leverage.
     
  18. Wysiwyg

    Wysiwyg Everyone wants money

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    Might be some interesting reading on this thread from Arturius for anyone.
     
  19. tech/a

    tech/a No Ordinary Duck

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    Very old school very basic 11 years old.
    System development has raced ahead
    AI is at the fore front.
    But a fantastic topic.
     
  20. DonDiego

    DonDiego

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    Many of the books recommended back then are still of use, still improve one's knowledge and provide tips, tricks and glossaries. I actually have fun borrowing investment & trading books from the local library. :)
     
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