Research Techniques Used in Day Trading
Day traders need to make decisions fast, and they need to have a framework for doing so. That’s why they rely on research. But what kind? Most day traders rely heavily on technical research, which is an analysis of charts formed by price patterns to measure the relative supply and demand for the security. But some use fundamental analysis to help inform their decisions, too.
Research systems fall into two categories: fundamental and technical:
Fundamental research looks at the specific factors that affect a security’s value. What’s the relationship between the trade deficit and futures on two-year treasury notes? What’s the prediction for summer rainfall in Iowa, and how will that affect December corn futures? How dependent is a company on new products to generate earnings growth?
Technical research looks at the supply and demand for the security itself. Are people buying more and more shares? Is the price going up a lot as they buy more, or does the price go up just a little bit? Does it seem like everyone who is likely to buy has already bought, and what does that mean for the future price?
Securities are affected by matters specific to each type and by huge global macroeconomic factors that affect every security in different ways. Some traders prefer to think of the big picture first, whereas others start small. And some use a combination of the two approaches. Neither is better; each is simply a different perspective on what’s happening in the markets.
Top-down research of day traders
With a top-down approach, the trader looks at the big economic factors: interest rates, exchange rates, government policies, and the like. How will these things affect a particular sector or security? Is this a good time to buy stocks or short interest rate futures?
The top-down approach can help evaluate the prices in big market sectors, and it can also help determine what factors are affecting trading in a subsector. You don’t have to trade stock market index futures to know that the outlook for the overall stock market will have an effect on the trading of any specific company’s stock.
Bottom-up research of day traders
Bottom-up analysis looks at the specific performance of the asset. It looks at the company’s prospects and then works backward to figure out how it will get there. What has to happen for a company’s stock price to go up 20 percent? What earnings does it have to report, what types of buyers have to materialize, and what else has to happen in the economy?