Ground rules for day trading

Day trading is challenging. Don’t let anyone tell you otherwise. The odds are stacked against you and the risks of loss seemingly lurks at every turn. That’s why it’s important to understand some ground rules about day trading. The rules are there so that you can safely swim with the sharks.

Range is Key for Day Trading

One of the most common mistakes with day trading is failing to identify the daily range. Say you’re planning to take a long on the EUR/USD. However, the pair’s already moved above its average daily range. What might be the result? Your trade could be doomed as the market tends to gravitate into its average range.

When you trade for a few hours most of the signals you count on are a few hours old. This means, essentially, that the signals are naturally soft and fluid. Markets, especially on an intraday interval, tend to gravitate towards its range. Thus fluid signals tend to be much less reliable.

Knowing the range of the interlay trade can lower your risk of loss. Moreover, used in your favor, it could also improve your gains.

How to identify the range?

There are many techniques to identify the true range, including the Moving Standard Deviation or Bollinger Bands.  However, those techniques tend to be more effective on swing trading. When day trading, I always recommend starting with what I call the top to bottom approach.

That is a method to identify your support and resistance levels in higher intervals, say, daily. Daily is actually ideal because it’s two levels up, compared to just hourly. Then you apply those levels on an hourly trade. What you get are solid levels you can count on rather than the fluid hourly support levels.

Down to Practice

This is a chart we used to identify the daily range. Now, we drill down into our desired interval. In this chart it’s the hourly interval, where we can get reliable resistance and support levels for either shorts or longs.

range_1Source: esignal

range_2Source: esignal

Be in and Out Quickly

You should never stay in a trade longer than you have to; that’s clear and common sense. This method can be more forgiving in longer duration trades, e.g., multi days to several weeks. However, in day trading, when trades are counted by the minute, then every minute counts.

Spend too long at a trade and there can be dire consequences. The market that is already less reliable at such low intervals could turn against you. And the chances this could occur continue to grow the longer your trade is open. Hence, you should always concentrate on minimizing the time your trade is open while maintaining a worthwhile profit.

Down to Practice

How do you implement this rule in real day trading? You make sure your limit per trade is much smaller than the daily range. Why? As you approach the daily resistance/support level, the odds start to turn against you. There is a greater likelihood that the market will turn around before your position has reached its “full potential.”

Trade small and target prices that are well within the daily range. That way, you improve your chance of hitting that “home run” and profiting from your position.

Beware the Trend

Of course, we’re all familiar with the old adage “the trend is your friend.” Well, to that I say if the trend’s a friend then who needs enemies? There’s a rule of thumb for day trading. If there’s a bullish long term trend (i.e. several weeks) and you’re trading a short then beware. The market will have a tendency to unexpectedly surge higher and move against you.

Implementation

Now, some day traders may simply avoid taking shorts in just such a scenario. Yet that doesn’t have to be the case. Instead, you might just take trades with significantly lower leverage. By doing so you balance out the risk associated with trading against the long term trend.

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