Successful short term stock trading is the dream of many people, yet very few are actually successful over the long term. Let's start out by defining the basic concepts for success in the short term trading game.
Perhaps the most important concept is stock knowledge. I do not mean fundamental knowledge of the underlying company whose stock you may wish to trade. I am referring to how the stock behaves and moves from trading session to trading session. All stocks have distinct personalities and choosing the stock with the correct "personality" is critical for success. For example, volatility, volume, and knowing whether the longer term trend is up or down are all important for short term stock trading.
Volatility: is the stock making large moves up or down? Or is it barely budging?
Volume: are there many buyers and sellers of the stock?
Trend: is the stock making higher highs and higher lows or lower highs and lower lows?
Strategy is the next critical concept. How will you enter and exit a short term trade? There are countless strategies, but in the stock market these strategies all boil down to one of a few different approaches: trend trading, counter-trend trading, breakout trading, pullback trading and reversal trading.
Trend trading is the form of trading least common in the short term. Trend trading involves buying a stock once it has established a trend of higher highs and higher lows and remaining with that stock until there is clear evidence that the trend has ended.
Counter-trend trading, on the other hand, is very short-term in nature. Various styles of counter-trend trading exist, most of them using different strategies to spot potential reversals in market trends. Counter-trend strategies are also popular for traders who are trading around larger, core positions.
Breakout trading involves buying stocks as the move up, usually suddenly, from areas where prices have been flat or otherwise moving sideways. Breakouts can be to the upside or downside (when they are called "breakdowns").
Pullback trading is a trading method that involves buying strong stocks when they are temporarily weak and selling weak stocks when they are temporarily strong. It is a form of mean reversion trading that looks for stocks that have become stretched beyond their normal trading levels to return to those levels.
Reversal trading is often a part of an overall trading strategy rather than a sole method for trading stocks in the short term. Reversal traders use some of the same techniques as counter-trend and pullback traders to spot markets that have moved too far in one direction and are ripe for reversal.
Money management, for the purpose of this article, refers to how much of your trading capital you will commit to any one trade. It also refers to how much you are willing to lose on any trade.
Money management is a very personal decision based on your risk tolerance, capital resources, belief in your trading strategy, method or system, and your experience as a trader. The correct strategy will make you money but proper money management will keep you in the game.
There are number of different important ideas in money management. From position sizing to hedging, and from the use of stops to scaling into and out of trades, all of these will play some part in helping traders use and deploy their capital wisely. Each will also be the subject of future articles on short term trading.
The final key to short term stock trading is discipline. This is the most difficult aspect of trading to master for most people. The ability to stick to your rules, wait for the perfect set up for your strategy, getting out of the trade if the trade does not perform as expected … all of these are aspects of the discipline necessary to be a successful short term stock trader.
Discipline is not something that can be taught. It needs to be developed over time. The ability to be disciplined and stick to a proven trading method or strategy is truly what separates the break-even short term traders from the experts who are profitable year after year.
Next we will start looking at a number of specific types of short term trading styles, as well as the strategies that traders use when using these different approaches to short term trading.
Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.
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