Day trading is fast-paced. It requires discipline and lightning-fast reflexes to pull the trigger once a promising trading opportunity reveals. It can be a lucrative and exciting trading style if you get the foundations right.
That’s why I recommend you first take our Trading for Beginners course. You’ll learn how to start trading by taking this unique course with myself. Cut your learning curve in half and get expert guidance on how to start trading the world’s financial markets.
1. Prepare for your trading day
As a day trader, preparation is one of the most important tasks you should start your day with. This includes not only analysing the market for potential trade setups but also mental and physical preparation and exercise.
Set your alarm early in the morning, so you can have time to do some short stretching exercises and get ready for the trading day. Before the stock market opening bell or the beginning of the Forex London session, scroll through your charts and see whether there are some potential trade setups that are in-line with your trading strategy.
Many day traders check the market late in the evening to prepare for the following trading day, which can also be an effective approach if you’re an evening owl.
Check out: Diary: A Day in the Life of a Day Trader
2. Analyse the first trading hour
The first trading hour of any financial market reveals a lot about the current trading day. Pending orders that were placed by traders the day before get executed in the first few minutes of the new trading day, which can provide valuable insight into where the market is heading.
Forex traders often follow the price-action of the early London session to get a feeling of the market pulse. If there’re large breakout candles, this often sets the tone for the remainder of the day. The same holds true for stock traders – feel the market sentiment by waiting for the first 1-hour candle of the stock you want to trade.
3. Check an economic calendar
Economic calendars include important market events and reports that can create extreme volatility in the market – and volatility is essential for day trading. The majority of economic calendars include the stock or currency that is likely impacted by the release, the forecasted number (also called Street expectation), the previous number and the actual release.
Checking an economic calendar for the most important market reports scheduled for the day should be a regular part of your morning preparation routine. Write down or remember the exact times of the releases to avoid any unpleasant surprises down the road.
Markets tend to be very volatile if the actual number differs from the expected number to a large extent. Depending on your market view, this volatility can work either for or against you.
4. Read relevant market news
While most day traders use technical analysis in their trading, it’s no secret that fundamentals play a crucial part in financial markets. Fundamentals can form new trends, reverse them, and cause important support and resistance levels to break, which makes it very important to follow market news when day trading.
Many traders use popular financial portals to stay up-to-date on market news, such as Bloomberg or Reuters. While you don’t have to read through any news that comes across, knowing what is going on in the market will help you with your market analysis and generate new trading ideas.
5. Find oversold and overbought financial instruments
The trading strategies of day traders can usually be grouped into three categories: trend-following, breakout trading, and counter-trend trading. Whichever strategy you use, finding and trading overbought and oversold financial instruments can make a significant impact on your bottom line.
Overbought securities tend to fall to their average trading range, while oversold securities tend to rise to their average trading range over time. A popular tool to identify securities that trade at those extreme levels is the Relative Strength Index, which comes built-in with most popular trading platforms.
Simply apply the RSI to your chart and read its value – a value of below 30 indicates an oversold market condition, while a value of above 70 signals an overbought market condition. Avoid buying securities that are overbought and selling securities that are oversold.
- Learn more, take our free course: Relative Strength Index: Fast Track
6. Take trades in the direction of the trend
Trend-following is one of the most popular trading strategies among day traders for a reason – it works. Trend-following refers to taking trades only in the direction of the established trend. If the current trend is up, look for buying opportunities, and if the current trend is down, look for selling opportunities.
To identify the current trend, you can use a simple peak and trough analysis or a technical indicator such as the ADX (Average Directional Index). A market in an uptrend forms consecutive higher highs and higher lows, while a downtrend market forms consecutive lower lows and lower highs. You’ll often find that, during an uptrend, securities become oversold exactly at the point of a fresh higher low, which is the price-level at which you should consider buying the security or currency pair.
Similarly, during downtrend, securities usually get overbought right at the point where a fresh lower high is forming, which signals a potential selling opportunity.
If you want to use the ADX indicator to identify and trade trends, then follow the value of the ADX line. A value below 25 indicates that the market is not trending, a value between 25 and 50 signals a trending market, while values above 50 signal a very strong trend. Use the –DI and +DI lines to identify the direction of the trend – if the –DI line is above the +DI line, you’re dealing with a downtrend, and if the +DI line is above the –DI line, you’re dealing with an uptrend.
7. Counter-trend trades can be risky
The opposite approach to trend-following, counter-trend trading refers to taking trades in the opposite direction of an established trend. Counter-trend traders aim to profit on short-term price-corrections, i.e. they try to sell at the top of higher highs during uptrend, and to buy at the bottom of lower lows during downtrends.
When combined with trend-following strategies, counter-trend trading can create more trading opportunities for traders. However, bear in mind that counter-trend trades are generally riskier than trades that are taken in the direction of the underlying trend.
8. Have strict risk management rules in place
Without sound risk management rules, even the best trading strategy will ultimately lead to large losses. Risk management helps you take control of your trades, position sizes, losses and profits. Not any single trade should be allowed to wipe out a large portion of your trading account, or you’ll have a hard time trying to get back to break-even.
For example, if you lose 50% of your trading account on a single trade or a couple of trades, it will take you 100% of profits only to return to breakeven. That’s why you should analyse the potential risk of any trade setup, use a predetermined risk-per-trade, take trades with a high enough reward-to-risk ratio, and follow the 6% rule.
9. Always risk a fixed percentage of your trading account on any trade
To avoid losses to get out of control, you should only risk a fixed percentage of your trading account on any single trade. The golden rule is to never risk more than 2% of your trading account on a trade. For example, if you have a $10,000 account, then you shouldn’t risk more than $200 on any single trade. Place your stop-loss exactly at the price-level where your total loss for that trade would equal $200.
While 2% is the maximum risk you should be taking on any single trade, you can reduce this percentage if you want. For traders with larger trading accounts, it’s common to risk only 1% or even 0.5% of their accounts.
10. Analyse the reward-to-risk ratio of potential setups
The reward-to-risk ratio of a trade refers to the potential profit of the trade divided by its potential loss. For example, if you’re taking a trade that has a profit potential of $50, but you’re risking $100, the reward-to-risk ratio of that trade would be 0.5. In other words, you’re risking $2 to gain $1.
This is an example of an unfavourable reward-to-risk ratio. You should never risk more than you can potentially gain. The best trade setups have a reward-to-risk ratio of at least 2:1 or even more, i.e. you’re risking $1 to gain 2$ or more.
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11. Follow the 6% rule
While the risk-per-trade rule of 2% is designed to protect you against a single large loss that can cause irreparable damage to your trading account, the 6% rule is designed to protect you against a large number of smaller losses.
This rule says that the maximum amount you should risk on all of your open trades shouldn’t exceed 6% of your trading account size. For example, if you stick by a risk-per-trade of 2%, the total number of trades you can have simultaneously open would be 3 (3 x 2% = 6%). However, if you reduce the risk-per-trade to 0.5%, then the maximum number of trades you can have simultaneously running climbs to 12 (12 x 0.5% = 6%).
The 6% rule is a great protective measure against a bad trading day. Imagine all of your open trades turn against you and hit stop loss, with the 6% rule you would be losing only 6% of your trading account.
- Learn more, take our popular course: Trading for Beginners
12. Use pending orders where possible
Pending orders include stop and limit orders that become market orders when certain conditions are met. Pending orders are extremely popular among breakout day traders.
Simply place a pending order above or below a potential breakout point, and the pending order will automatically execute a market order once the price reaches the pre-specified price level. This way, traders don’t have to wait in front of their trading platforms all day long to catch a breakout trade.
Pending orders can also reduce slippage, as they get filled only when the market reaches the pre-specified price or don’t get filled at all.
13. Keep a trading journal
Trading journals are a great way to improve your day trading skills if used the correct way. In general, trading journals should include all the trades you’ve taken in the past, with their respective entry levels, stop-loss and take-profit levels, reasons for taking the trade, position sizes and other information you may find relevant.
14. Make regular retrospectives of your trade history
If you’re regularly keeping a trading journal, then don’t forget to perform retrospectives of your journal entries from time to time. This can be done once a week or once a month, for example.
These journal retrospectives will help you identify recurring trading mistakes that have led to losing trades. Is it a certain chart pattern that simply doesn’t work for you? Or do you place your take-profits too wide and stop-losses too tight? A trading journal retrospective will provide answers to those and other questions.
15. Wait for confirmation before entering a trade
Did you find a trade setup worth trading? Everything is in line with your trading strategy, and you’ve identified levels to place your stop-loss and take-profit orders? Great! But, before you pull the trigger, waiting for confirmation can increase your success rate significantly.
A trade confirmation refers to market behaviour that confirms your analysis, i.e. the price starts to move in your direction and proves that your analysis looks correct.
Candlestick patterns are a great tool to confirm a trade. Patterns such as engulfing patterns, morning and evening stars, dojis, hammers, and pinbars are often used by day traders to confirm a trade setup and finally open the trade.
If you’re trading breakouts, you can also wait for the close of the breakout candle before entering into a trade. This is done to prevent fake breakouts and minimise potential losses.
16. Don’t let emotions interfere with your trading decisions
Trading based on emotions is one of the most common mistakes made by day traders that enormously affect their trading performance. Emotions, such as fear and greed, cause traders to let their losses run and cut their profits short – both actions that can make significant damage to your trading account.
How to prevent emotions to interfere with your trading and keep a cool head? The best solution is to have a well-defined trading plan and to only take trades that align with your strategy. A complete trading plan should also describe your risk management and entry and exit points. It creates a systematic approach to trading – one which has a much larger rate of success than trading based on emotions.
17. Always use stop-losses
Whether you are day trading, swing trading or scalping, you should use stop-loss orders in all of your trades. Stop-losses prevent large and unpredictable losses and play a crucial part in risk management. Without stop-losses, you won’t be able to have a precise risk-per-trade or apply the 6% rule.
There are four main types of stop-losses: chart stops, volatility stops, time stops and percentage stops. Out of these four types, chart stops return the best results. Chart stops use important technical levels in a chart, such as support and resistance zones, to find the best places for stop-loss orders.
18. Protect your profits
One of the biggest mistakes of day traders is that they don’t protect their unrealised profits. When you open a trade and it moves into profitable territory, those profits are still not your own. They’re unrealised until you close the position either entirely or move your stop-loss above your break-even level. Once you do that, unrealised profits become realised and protected.
As a rule of thumb, you should protect your profits as your trade reaches closer to TP. When the trade reaches 1/3 of your TP, move the SL to breakeven, and when it reaches 2/3 of your TP, move the SL to 1/3 of TP.
19. Use trailing stops where possible
Another efficient way to protect your unrealised profits is by using trailing stops. As their name suggests, trailing stops “trail” the price – with each new price-tick in your favour, a trailing stop moves your stop-loss one tick in your favour. However, if the new price-tick is not in your favour, your stop-loss will stay at its most recent level.
Trailing stops are especially popular among trend-following day traders. By using trailing stops, they’re able to stay inside a trend as long as it lasts and squeeze the most profits out of it.
20. Don’t trade during important market reports
Day traders live on volatility, and market reports often provide the necessary volatility for profitable trades. Without volatility, there’s no risk and no profits to be made.
However, trading during important market reports can create an environment of unnecessary risk as markets are notorious to create large spikes in the seconds following a release. These spikes often lead to a large widening of spreads, slippage and the triggering of stop-loss orders.
21. Holding trades overnight can be risky
Day traders are day traders because they hold their trades for a single day at most – that’s it. Most day traders open their trades in the morning and let them run until either their stop-loss or take-profit gets triggered.
If a trade is still open by the end of the trading day, close it and take the loss or profit. Holding trades overnight puts you at the mercy of market movements that may not be in your favour.
22. Create a portfolio of trades
Last but not least, consider creating a portfolio of trades to reduce your risk. Portfolio work on any timeframe, even for day trading. For example, if you’ve already taken three trades that are long the US dollar, consider adding a fourth trade that is inversely correlated to the first three trades that you’ve taken (for example, gold). This will prevent that a single trade or a couple of trades create large damage to your trading account.
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