Day trading is a high-risk, high-reward trading strategy that was once the sole province of hedge funds, investment banks and seasoned money managers. The advent of broadband Internet connections and responsive, intuitive online brokerage platforms has changed this dynamic. Today, it’s possible for virtually anyone with a keen understanding of the financial markets to buy and sell stocks for short-term gain. As you choose stocks for day trading, keep these important points in mind.
1) Pay Attention to Liquidity
It’s very difficult to day-trade equities that lack large share floats. However, highly liquid firms tend to trade at lower multiples than less-liquid names. Accordingly, look for equities that split this difference. Ideal short-term trading candidates have ample share floats and trade at high multiples relative to their peers. Even if you find yourself on the wrong side of the trade, these equities usually offer an easy exit strategy that can reduce your losses.
2) Volatility Is Key
There are many different types of market volatility. For day traders, firms that have been mispriced due to macroeconomic factors or external events offer particularly attractive opportunities. During much of 2011 and 2012, the Eurozone crisis caused a prolonged, largely artificial volatility spike that overrode the rational instincts of even the most seasoned traders. Unfavorable events — like the extension of an E.U. bailout to peripheral Eurozone economies or the failure of a closely watched Italian bond auction — caused quick downside moves that allowed enterprising day traders to buy fundamentally sound names at steep discounts.
Likewise, volatility within specific firms can be brought on by unpredictable cash flows or surprising earnings reports. Look for companies with unsteady balance sheets and a history of earnings beats or misses. Alternatively, examine the Trade Volume Index for specific firms. For various reasons, trading volume often spikes before big upside or downside moves.
3) Look to the Banks
Ironically, many public firms that earn tremendous profits through short-term trading operations make for excellent trading targets. Companies like Citigroup, Bank of America and J.P. Morgan Chase are highly liquid and often track broader-market indexes. Even better, these firms tend to be sensitive to macroeconomic reports and news headlines. In the wake of the financial crisis, many day traders made a killing off of unsteady banks’ volatile price swings.
4) Find Social Media and Web 2.0 Gems
The rapidly evolving technology sector has a checkered past, but the relatively recent emergence of viable social media and Web 2.0 stocks offers a real opportunity for day traders. Firms like Facebook, Groupon and LinkedIn tend to move in response to news and events that affect the broader technology sector. Additionally, their ongoing struggle to monetize their services has produced a slew of unpredictable earnings reports and cash flow figures. Since they’re relatively liquid and trade at high multiples, these companies tend to offer wider spreads for profit-hungry day traders.
Not all equities are suitable for day trading. Use these tips and your own original research to choose exciting names that minimize the risk of your chosen short-term trading strategy.
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