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Cheat Sheet

Day Trading For Dummies

If you want to get started in day trading, doing some preparation before you dive in dramatically increases your odds of success. From setting up your trading business (and it is a business) and learning trading jargon to tracking the markets with technical indicators and calculating your performance, these articles get you on your way.

Equipment for a Day Trader's Office

If you want to work as a day trader from a home office, the right equipment will let you act quickly when you need to trade and help you stay organized. Here's the basic setup you'll need:

  • A PC with a good monitor: Most personal computers sold nowadays have the processing power to handle day trading. Because you'll be spending a lot of time in front of it, do yourself a favor and get at least one large flat-screen monitor so that you can have at least two windows open at once.

  • A second PC or mobile backup: Computers are fickle. No matter which brand you buy, you're subject to different mechanical or software glitches that can shut you down. That's why it's good to have a duplicate of your system on a laptop or at least have your broker's app on your phone so that you can switch over quickly.

  • High-speed Internet access: You need a fast, reliable connection with backup service. Period.

  • Spreadsheet software: Still haven't figured out Microsoft Excel? It's time. Spreadsheets will help you track performance and analyze returns. (Excel 2013 For Dummies, by Greg Harvey [Wiley] can help you figure it out.)

  • An online brokerage account: Several brokerage firms specialize in the needs of high-volume traders. They offer online access, real-time quotes, backtesting and other analytical services, and low commission to those who make many trades.

Day-Trading Lingo to Know

Every business has its own special language, and day trading is no different. Here are a few terms you may come across:

  • Fibonacci series: The Fibonacci series is a list of numbers, each of which is the sum of the two numbers before it. It stretches into infinity but starts like this: 0, 1, 1, 2, 3, 5, 8, 13. Proportions based on the Fibonacci series show up throughout nature, and many believe that they indicate profitable trading opportunities.

  • Kelly criterion: Want to trade with a guarantee of success? It's mathematically possible using the Kelly criterion. In its simplest version, the percentage of your account that you trade is equal to the probability of the trade going up minus the probability of it going down. If your testing shows you that a strategy works 60 percent of the time and fails 40 percent of the time, then each time you trade with it, you would trade 20 percent of your funds: 0.60 – 0.40.

  • Pattern day trader: Regulations define this as someone with at least $25,000 on account, who executes four or more day trades within five business days, with those trades representing more than six percent of the customer's total trades. This is important for how the brokerage firm handles margin activity.

  • Wash-sale rule: The wash-sale rule is a tax trap that catches many day traders. It says that if you sell a security at a loss, you can't deduct the loss if you buy the same security 30 days before or after the sale. Day traders might buy and sell the same security several times in one day. There are ways around the wash-sale rule, but they require some planning and careful recordkeeping.

Trading with Technical Analysis Indicators

Using technical analysis, day traders often look for patterns in recent prices and trading volume to determine whether a security is likely to do especially well or especially poorly. Here are brief definitions of some technical indicators you're likely to come across:

  • Average true range: The true range is found by calculating the exponential average of the difference between the higher of today's high and yesterday's close and the lower of today's low and yesterday's close. Average these for 14 days, and you get the average true range. Usually, you sell a security trading at or above the high and buy one trading at or above the low.

  • Bollinger Bands: A Bollinger Band is a trading limit set at two standard deviations above and below the 20-day moving average of a security. Traders look to sell near the top of the band and buy near the bottom.

  • Commodity Channel Index (CCI): This technique is used to identify seasonal turns in agricultural commodities and other securities that have different supply and demand levels during the course of the year. When a security goes above the CCI, it's probably time to sell.

  • Momentum: Traders looking for momentum buy securities that are going up in price if the volume traded is also going up, and they sell securities that are going down in price if the volume traded is going down.

  • Relative Strength Index (RSI): The Relative Strength Index is the average of the number of upward price movements in a period divided by the average of the number of downward price movements. The higher the RSI, the more interested people are in buying rather than selling.

Calculating Your Day Trading Performance

The goal of day trading is to make money, but when the trades are coming fast and furious, figuring out how you're doing can be hard. Here are a couple simple ideas that let you gauge your performance as a day trader:

  • Batting average: What's the number of winning trades relative to the total number of trades you make? This number gives you a rough idea of how often you're making money, although it doesn't tell you how much money you're making. If at least half of your trades are winners, you're on the right track.

  • Modified Dietz method: This is a quick way to gauge your performance when you have been adding money to your account or taking it out. What it loses in accuracy, it makes up for in simplicity. Here's the equation for the Modified Dietz method:

    image0.png

    EOY represents the end of year asset value and BOY represents the beginning of year value.

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