Our next day trading strategy stipulates that a series of consecutively smaller ranging bars occurring in a single direction will lead to a reversal when the proper conditions are met. This setup can be taken with or without a gap and is a counter trade. Just as with the opening reversal gap fill strategy, this trading setup goes counter to the early morning activity and should be taken with caution and regard for the overall market condition as you are ready to place the trade. The best trades are the ones which are taken in the direction of the daily trend and also have the broad market indicators at their back.  It is important to note that in a very strong trend, it is not advisable to take this trade.  Many times, these breakdowns or breakouts will be shakeouts for a move back in the primary trend.  Additionally, high volume tops have a fairly high chance of being retested (forming a double top) before they move lower.  If you get stopped out on your first position, it is acceptable to take a second position if a double top forms.

The Setup

The setup is fairly simple; we are looking for a general series of consecutively smaller bars, typically between 4 and 6, beginning with the opening 5 minute bar, ending with a reversal bar. A reversal bar may come in the form of a hammer, doji, or even a bullish or bearish engulfing bar. I like to see heavy volume on the reversal as it indicates exhaustion or it can indicate a heavy battle. If the battle is lost by the bulls in the uptrend, a move below the reversal bar will indicate a change in trend. As usual, it is important to watch the action on the time and sales window to confirm the selling through a support area.

Money Management

You can immediately place your stop above the high of the reversal bar and use the 10 period EMA to walk the stock down. From experience, this day trading setup is not one that a trader should expect large gains from. In fact, I have seen extremely fast gains come out of this position as traders will pile on as profit taking is due and no one wants to give up much of their gains. However, Fibonacci retracement levels should be looked at carefully; especially the 38%, 50% and 62% retracement areas. This is typically where these pullbacks will find support or resistance (in the case of a long signal) and move back higher. It would be prudent to at least take a portion of the position off and carefully watch the balance as these fib numbers are hit.

This article is going to discuss a very simple, yet powerful, day trading strategy that is used to capitalize off of the greed and fear from a group of novice traders. I refer to this setup as a “three bar reversal and go“; it can be described as a stock that has recently made new intraday highs and then abruptly stages a pullback in the form of three to five bars on light volume. I look for a reversal bar on the final bar of the pullback and use that as the trigger bar. Once the high of the trigger bar is penetrated, a long entry can be established.

You can actually practice trading this setup using our trading simulator which replays real historical tick data.

Now, there are a few rules I use to identify the most powerful day trading setups. Firstly, you want to look at the volume on the pullback bars. They should be lighter than the preceding up bars. Second, the trigger bar should be a reversal bar that opens lower and closes near the high of the bar. You can see some common candlestick charting reversal patterns as a guide. Third, keep an eye on the “tape”, or the time and sales window; you want to make sure that the breakout above the trigger bar has some conviction behind it. This day trading setup can be used on any time frame chart; however, I like to use it on five minute charts.

Psychology

They psychology of this setup takes advantage of newbie’s, or novice traders. First, breakout buyers will step in when they see fresh new highs being set for the trading session. These new buyers will immediately see the stock reverse on them and consider the breakout to be a false one. As the stock continues lower, these traders will become fearful and sell out for a loss, only to have more experienced traders step up and buy into that fear. More experienced traders, using the rules outlined above, will understand that the stock is still bullish and step in at the top of the trigger bar.

Risk Management

The setup is pretty easy to trade from a risk management perspective. I will stop this trade out below the low of the trigger bar. The reward to risk ratio on this trade is very much in your favor. Look for the previous highs of the day to exit at least half, if not all, of the position.

Example

Three bar reversal and go example

What are Breakouts?

When you think of day trading breakouts, what comes to mind?  Stocks making daily highs, two-day highs, weekly highs, all-time highs?  As you see, breakout means a lot of things to a lot of people. So, why do so many people lose money day trading breakouts? Why are traders constantly buying stocks when they hit intraday highs, only to have them rollover within minutes. How many times have you shorted a stock on a breakdown through a critical support level, go get coffee, come back and see the stock has bounced and you just bought a five-thousand dollar no foam, soy latte? Well, in this article I will give you the “secret” that so many breakout day trading professionals use everyday to take themselves from ordinary to extraordinary.

After you read this article in its entirety, do yourself a favor and try out our day trading simulator.  We are so confident in our application, we offer a free-trial period for 7-days to test drive the application.

Biggest Misconception about Day Trading Breakouts

If I buy a breakout or sell a breakdown, I will make money, right?  If you believe this statement, immediately contact your broker, withdraw your funds and put them in a savings account.  If you follow this system, you will lose money.  Often times professional floor traders and the like will wait for stocks to break new lows, look for large buy orders in the tape and then start scooping up every share in sight. This will leave you the novice trader, looking at your screen scratching your head. Asking yourself the question, how did this happen? My technical indicators were in alignment. The stock has been below its simple moving average the last 10 bars. The last 15 bars have been down, now when I put on my short position, the stock has the bounce of its life. If you are ready to end your streak of tough trading days, continue reading.

Avoid Trading During Lunch

In the morning, there is news, earnings, gossip, and a multitude of other reasons that cause stocks to move swiftly with heavy volume. Then around lunch, traders take a step back and begin to digest all of the events from the morning. This does not mean there are no good breakouts in the market, but the odds of finding the stocks that will move are not in your favor. It’s a known fact on the street that lunch time trading is for accumulating sizeable positions that you can then unload at some point in the future. That is why, during the middle of the day, stocks go through an endless process of breaking out and failing, over and over again. This process is known as intraday accumulation. Think for a second, if you are attempting to accumulate 200,000 shares of a stock. Could you just run out there and put one large order in the market without anyone seeing you?  Maybe on a stock like Yahoo, but this is a much harder task in a stock that is not traded heavily. Well if the trading is light, I’ll just put the trade on in the morning.  Wrong.  If you put the trade on in the morning, you can easily get caught up in the morning volatility and may not get the best price. However, if you wait until the afternoon, you can quietly accumulate shares, 10,000 or so each time you buy, without many noticing. So, if you were doing this, would you want the stock to breakout? Of course not, this would mean you would have to pay more per share. So, instead you keep things quiet and by 2 pm, you have been able to acquire your 200,000 shares, over the last 3 hours, under the radar. So, if you are a smaller trader, why get trapped taking on positions during the accumulation period?  Why put yourself through the emotional stress of watching your stock breakout and fail, over and over again? If you only remember one thing from this article, middle of the day is for hedge funds and large institutions to build sizeable positions, not for you to day trade breakouts.

Who is Making Money Day Trading Breakouts

The “secret” for day trading breakouts is knowing when to trade them. Are you ready for this? Are you sitting down? There are only 2 to 3 hours per trading session you can day trade breakouts on an intraday basis. That’s right. If you are day trading breakouts, you only have about 2 hours a day where you can make money easily, quickly, without much effort.

What Times Work

The optimum times to day trade breakouts is between 9:45 am and 10:45 am and 2:00 pm – 3:15 pm. Most traders say stay away from the morning and late afternoon trading, because it’s too volatile, right? Well, that is partially a true statement, if you just go out into the market putting on trades without any defined rules or systems in place. Below are some basic rules that will help you identify winning breakout trades during these volatile time periods:

• Only trade stocks greater than 30 bucks
  • Cheap stocks get cheaper. Often times traders like the idea of trading cheap stocks in hopes of greater returns. What about the inherit risk of trading cheaper stocks, the volatile swings, and not to mention the commissions?
• Do not fade gaps
  • Yes gaps get filled. The question is, will it get filled in the timeframe you need it to. If you are day trading breakouts, you need things to happen quickly and precisely. You do not have time to wait around for the stock to act appropriately. Remember, it is always easier to go with the trend.
• Avoid stocks that are up or down more than 5%
  • You do not want to get involved with a 50% retracement on a 10% move. That’s 5% for those of you keeping count.
• Only trade stocks that have a minimum of 2 dollar price range from the previous days high or low
  • Remember, the goal here is to day trade breakouts. The greater the recent trading range, the greater your odds are of being in a stock that has room to trend.

In Summary

There are times you can day trade breakouts throughout the entire day, but more times than others you will either breakeven, or make little money. Remember, day trading breakouts should be easy money, not a fight.  So, continue to average up and let your profits run.

The morning reversal gap fill is another great trading setup for the first hour of trading, preferably within the first 20 to 30 minutes of trading. This strategy is a play on a shift in market momentum and is directly tied to market manipulation by the market maker on the open. As we discussed in our introduction to morning gaps, the market maker can legally manipulate the opening price of a stock and a reversal can occur under the right circumstances.

Trading Rules

 

Money Management

The first morning trading strategy we will discuss is a very simple, commonly used, and reliable trading pattern; the early morning range breakout. This strategy allows traders to take advantage of the violent whipsaw action that can result from the flurry of buy and sell orders that come into the market on the open, up until a few minutes after the market has opened. As traders, we sit on our hands and watch for ranges to develop on some of the more popular stocks of the day. As we watch on the sidelines, we allow the other traders to fight against each other until one side wins. Typically, you want to give the range 30 minutes or 60 minutes to develop before you trade in the direction of the breakout. I prefer the 30 minute range as there is a bit more volatility in this timeframe as compared to the 60 minute range. 

As with most setups, the EMRB tends to work best with large cap stocks which do not have wild swings. I do not like trading this strategy with stocks which have gapped up or down by more than 10%. Ideally, the stock should trade within a range which is smaller than the average daily range of the stock. The upper and lower boundaries of the range can be identified by the high and low of the first 30 or 60 minutes. This high and low should be made on separate candlesticks. For buys, the low should be tested before moving higher, similar to a double bottom. Conversely, shorting candidates should form a double top against the top of the range before breaking down through the support levels.

The idea is to go long on a break above resistance, or short on a break below support. Is it that easy? Not quite. You need to understand how to read the order flow, discern which day trading time zone you are trading within, and also understand the volume relationships that are being formed. 

Let’s start with the order flow; the time and sales window will be an invaluable tool for day traders to use in order to understand if the breakout is for real or not. As we have discussed in detail in our lesson on tape reading, it is essential that there is conviction behind a move above or below the range. We need heavy volume but also the right type of volume; meaning, if we have a stock breaking out to the upside we want to see heavy bids coming into the market rather than heavy offers at these levels. 

Secondly, different times during the day bring in different types of traders and could result in a perfectly good technical setup which fights against the prevailing market dynamics at that time. Be sure to understand the reversal time zones in the market. Finally, price and volume must be in sync. If you plan on shorting a stock which has gapped down, you want to see the stock gap down on heavy volume and then retrace on lighter volume (indicating a lack of buying) before moving lower again on heavy volume through the support area. This confirms that the sellers are in control. The early morning range breakout is a great trade from a risk perspective because it one that should be exited fairly quickly if there is no continuation after the breakout. Traders should not wait around and HOPE that the breakout was legitimate even though it has fallen back into the range. It is paramount that we protect our capital at all times. Learning when to stay in and when to get out is partly following your rules but also being able to process what you are seeing on the tape very quickly. 

Practice, practice, practice. You will start to feel the market after you get used to trading this type of setup. Be aware that some stocks will have very large bid ask spreads which could alter your money management and open you up to higher levels of risk than you are willing to assume. Remember, there is always another trade and you shouldn’t take a trade that doesn’t fit within your criteria. Here are some points to consider. First, traders should be aware of the support and resistance levels on a larger timeframe. By using Fibonacci retracement levels and pivot points, you can get a good idea of where your trade will find friction. If this level is too close to your entry, it may be a trade not worth taking or at least one that requires very tight stop loss parameters. Secondly, this pattern is far more successful when the stock is hovering at, or near, a price area which is closer to the direction of the anticipated breakout. When there is no directional bias within a range, traders need to exercise caution as a breakout in either direction may not have strength behind it.

Here is an ideal setup of the symmetrical triangle as I trade it.

Let’s review a few rules that I use to successfully trade the symmetrical triangle.  I want to mention that I only trade this pattern if it is a continuation in the primary direction.

I will discuss these rules in terms of the bullish version of this pattern.  The rules for the bearish version can be reversed.

1)  The Advance: There should be a strong advance before the formation of a symmetrical triangle.  Notice the advance in our diagram above.

2)  Retracement: For my day trading style, this rule is very important.  The retracement created from the top of the early morning advance should be no more than 50% of the advance, but ideally only 38% to 40%.  The smaller the retracement, the better the odds of continuation.

3)  The Setup: The symmetrical triangle should be viewed as a 4 point formation, with lower highs and higher lows until it breaks out.  The top of the early morning advance is considered to be point 1 while the reaction off of that level is considered point 2.  A rally to point 3 will lead to a reversal below Point 1 and a decline into point 4 will lead to a bottom at a higher level than point 2.

4)  Volume: This is key.  Once the early morning advance is complete, volume should die down and stay relatively low during within the formation of the triangle.  However, as you can see, a strong expansion should occur on the breakout bars.  This is one rule which can be different for the bullish and bearish triangle.  Markets don’t need heavy volume to fall but should have heavier volume when they rise.  When looking for a bearish continuation breakout, volume is not all that important.

5)  Breakout: Many novice traders will look for stock to break out right at the apex of the triangle.  This is not what we want.  You want to see the breakout occur about 75% of the way into the triangle.

5)  Price Projections: The price projection can be calculated by taking the highest point on the upper trendline and subtracting the lowest point of the lower trendline and adding that difference to the breakout point from the triangle.  For example, if the triangle started at 50 and retraced down to point 2 at 40, the upside target would be 10 points higher than where the stock broke out.

6)  Money Management: There is the possibility of a false breakout and therefore, stops should be placed beneath the lower uptrend line after breakout.  Additionally, once the position moves in my favor by 1%, I set the stop to break even.

Stay true to these rules and you will stay on the right side of this pattern most of the time.  Remember, it does not come up all that frequently so have patience and only take the setups that fall within the rules.

Our next strategy, the gap pullback buy, is one of my favorite setups.  It allows us to let the morning action play out and enter into a trade with a strong setup and relatively low amounts of risk.

Trading Characteristics of a Gap Pullback Buy

Volume is key to this strategy and it is important to note that we want to see the stock open on huge volume followed by a further advance of 1 to 3 bars on lighter volume. It is in this light volume advance where we will see the lack of leadership and the precursor to a move lower. At this point we do nothing, except for observe the volume behavior. We are not attempting to pick a top and go short.

The presence of heavy volume and a strong reversal suggest that the big money is supporting this stock. This is exactly what we want to see as traders who are looking to follow the money.

Money Management

The rules for taking this trade and stopping it out are fairly simple. A long position should only be taken when price penetrates above the high of the reversal bar. A stop loss order should immediately be placed below the low of that bar and if the range of the bar is too large, move your position size down so that you are able to trade the setup the way it was intended to be traded. One of my personal rules is to set my stop to breakeven the second I am up 1% on the position. It is absolutely unacceptable as a day trader to be up on a trade by a significant amount and end up taking a loss on it.

Day Trading Money Management

Day trading as a business can be very profitable. It is probably the safest form of investing, as you are focusing on a small number of positions, you are not holding any positions overnight and you are able to enter and exit trades with pinpoint accuracy. However, many day traders find themselves losing due to poor day trading money management.

How Much Should You Risk

The size of your trading position, is in direct proportion to the value of your portfolio. The key to day trading success is to avoid big losers. I can not tell you how many times early in my trading career, that I would be up huge over a 5-day period, only to have a big loser wipe out 50% of my gains. So, to avoid this bad habit, you should only risk a total of 1% of your portfolio on any one trade. Most traders take this rule of thumb, and just put a 1% stop loss out there and when that is hit, they just take the loss. If you have put on around 1,000 day trades or more, you know all too well that a 1% loss can happen. So, in order to avoid taking constant hits, you should allow yourself to take a 2% hit on your position, where the dollar loss from this trade will only represent 1% of your overall account value. Now that I have confused both of us, let me try to say that a little easier. You simply want the total dollar amount invested per position, to equate to 12.5% of your total marginable equity. So, if your account value is $100,000 you will have $400,000 dollars in margin buying power, and should use $50,000 for each trade. Remember, this $50,000 you use only represents 12.5% of your marginable equity. This way if you take a 2% hit, it will only be 1% of your total account value.

Stops are not meant to be hit

It really upsets me when I hear so called professionals advise new traders to set stop loss amounts. Doesn’t that seem like a general rule? Trading is a game of precision, and does not operate in the realm of gray. Yes, you need a stop loss order for every trade, but it is a fail safe. In this article we have discussed the power of a 2% stop rule and overall day trading money management. But do you think you should let every losing trade hit your stop? Of course not. Now I am not suggesting that we all become rogue traders and trade without stops.  The minute you see that the trade is wrong, get out with small hit. Because in the end, the goal here is to see a small number of .25% or .5% losses, while your winners are in the range of 1%-3%. This is how you will win the game. Again, the 2% stop loss is for the unexpected sharp counter move, and it is not your goal to have this stop hit. You should know well before your stop is hit if you are in a bad trade.

Operate in Cash

Day trading is a cash business. The only loan you should be using is with your day trading margin buying power. Do not start or continue to day trade, if you have to take out loans, credit, or use part of your retirement to get in the game. Traders that operate with a positive cash flow and utilize day trading money management rules, have a much higher success rate than traders that start out in the red.

Automated Day Trading Definition

Automated day trading is when a trading system places orders in the market without any human interaction.  These systems work best for traders who are unable to manage their emotions and or have poor money management techniques.  With a number of direct access brokers providing automated trading, it is no longer just an option for large banking institutions.

Pros of Automated Day Trading

There are very few traders that can handle the emotional runs that come with actively trading in the market.  Day trading requires you to have a constant conversation about risk, entries, exits, etc.  Since the market is actively moving, you have to constantly react as an active trader.  This is where an automated trading system will help.  The system will identify the trading opportunities and execute the orders.  This allows the day trader to step back and simply watch their system at work.

Cons of Automated Day Trading

Each day in the market is completely different.  Some days the market will trend, while other days the market will be completely choppy.  Traders of course will be able to react to the market environment, while the majority of systems are only optimized for specific market situations.   Lastly, unless you develop the trading system yourself, you have no idea how the system works.   So, if you purchase a “holy grail”, how do you know when it is broken?  Are you suppose to just sit there and wait for your account to hit zero before you cut off the trading robot?

Popular Automated Day Trading Systems

Automated day trading systems perform best when they are focused on one security.  The popular systems target the e-minis and forex.  System traders are most attracted to the forex market due to the clean price structure and available leverage.  When looking for a system make sure you can monitor it in a trading simulator before putting up any real cash.

Summary

In summary an automated day trading system can take the emotions out of trading and reduces trading to simple rules.  Remember though, that there is no free lunch in the market, so traders will have to determine how well a respective system fits into their trading profile.  Lastly, the trader must test drive the system for an extended period of time before committing any money to the system.

When you think of day trading breakouts the first time frame that comes to mind is likely the morning.  This is a natural first reaction as the morning presents the greatest odds of volatility with overnight news, morning earning reports, and early morning economic data.  There is however the possibility to make money trading breakouts in the latter part of the day.  In the morning, trading breakouts are pretty straight forward, high volume is accompanied by strong movements in price.  The afternoon is a bit trickier.  The volume is likely much lighter and the stock may appear to move up or down with very little rhyme or reason.  You will often find that a light volume buy order can send a stock up effortlessly which can have you on the wrong side of the trade.  The key thing is to find short-term levels that can give you the juice you need to capture a strong move.

Late Day Breakout Rules

1. High/Low from previous day has not been violated
2. High/Low for both the current day and previous day are exceeded after 2pm

Psychology Behind the Trade

Most active traders will place limit orders above and below the highs of the day.  The longer these levels hold true the more orders are added to these levels on the short-term.  So, on the opening of the second day as the market moves hard in the direction of the previous high/low only to be turned away prior to hitting the level, more orders are added to the previous day’s high as this as seen as a significant level.  The afternoon trading from 11-2 now becomes a battle ground for supply and demand as traders try to test the waters on the primary direction of the trend.  Once the market begins to break in the afternoon it now has a number of things going in its favor.  (1) All of the cause (accumulation/distribution) built up from the lunch time trading, (2) limit orders above/below the current and previous days levels, and (3) the fact no trader wants to hold a stock breaking in one direction hard over night.  All of these items converge late in the day to push the stock through key levels and then the stops are tripped.  Now don’t get too greedy as these short bursts are just that – short.  You are capitalizing on short swings based on the tight coiling of price action over a two day period.

Now that we have covered both the rules and psychology behind the trade, let’s dig into some real world examples.

Example #1 – DELL 2/8/13

On February 7, 2013 Dell made a high of 13.55 early in the day.  Dell then went flat and on the morning of 2/8 made another run at the 13.55 high.  You will notice from the chart this move was made on an increase in volume.  At this point traders that believe the stock has run out of gas will place their cover orders slightly above 13.55.  Conversely, traders looking to get long will place buy limit orders above 13.55, because if the stock is able to climb above this level its further confirmation the bulls are in control.  From the 13.55 high set on 2/8 Dell floats sideways for close to 6 hours.  In the world of day trading, 6 hours is an eternity.  Then late in the day you will see that the stock begins to make a move up on volume.  There are three white soldiers taking the stock higher on volume as it slices through 13.55.  So, at 3:3o if you are short, you do not want to hold onto this position going into the end of the day, so you cover.  All of the shorts who had their stops right above 13.55 also cover.  Lastly, the bulls will add to the buying pressure.  While the percentage move in this example is not huge, relative to the price action of the previous two days, this level of volatility is appears to be random.  However, from studying the chart and the tape you can clearly see why the break of 13.55 produced such a move.

Example #2 Dell – 1/14/13

Transcript of Late Day Trading Breakout Video

Hello everyone this is Al Hill, co-founder of Tradingsim.com. To simulate the lesson that we are going to cover in this video visit tradingsim.com or give us a call at 888.610.2734. Hey day traders, this is Al Hill form tradingsim.com. So, in the article we touched upon the late day breakout strategy. We gave you a pretty vanilla example, something that’s realistic you can look at it and say to yourself, you know what, this is in fact possible. Well, in this example we are going to have a little bit of fun; trading doesn’t have to always be so uptight. So, we are going to look at Dell again from early January. January 11th we had a high of 11.02, this was set first thing in the morning. On the 14th you could see we opened up at 10.89 and we went down for a little bit and then traded sideways pretty much during the middle of the day, which is really what you want to see right. Between 11 o’clock and noon you want to kind of even out, bulls and bears are in a dead lock and supply and demand kind of you know could go either way. So, then you want to start to look at your highs and lows from the previous days. So your low from the previous day was 10.76 and your high was 11.02. You can see in here we got around 10.97, 10.96 and kind of just floated. Now again, as we said in the article you want your breakout to come in the latter part of the day. Reason being you are going to break the highs of your current day, so that will give you a little bit of juice when your current day highs are broken as well as your previous day’s high. So now you have also any sort of shorts that have their stops up here as well as the longs, that you know, want to see the confirmation the move has gone in their direction they are going to have buy limit orders out there. So in this example, Dell, everything looks normal right, let’s fast forward a little bit. Everything looks normal and then all of a sudden, I mean the action just explodes. Now you know, again the odds of you catching a move like this are one in a million but it’s always cool to see these things play out. Again this is the late day breakout strategy. Now something like this which you will see shortly is always tied to some sort of news event, be it economic or specific to the stock itself. Now look at this right, let me shut up for a second, this thing I mean literally just explodes, now up 10%, so it is possible but again you have to be on the right side of the market and you have to be aware of these types of patterns. Now, it can be much easier to catch these types of moves if you have a scanner or some sort of proprietary system where you are out there looking through hundreds of charts or hundreds of symbols trying to find these diamonds in the rough. Alright, so again the late day breakout strategy at its best. Take Care and good luck trading.

The post Day Trading Breakouts at the End of the Day appeared first on Tradingsim Online Trading Simulator.

This article is a review of the day trading cup breakouts strategy presented by Ken Calhoun in Stocks and Commodities Magazine. Let’s lay down the ground rules for the pattern.

1. The pattern is to be used for day trading activities
2. Use 1-minute chart time frame
3. 35-day moving average
4. Two-day time frame
5. Need a cup pattern on light volume
6. The breakout needs to occur on high volume
7. The breakout must exceed the high or low of the previous day by .35% during the first hour of trading

A working example of the setup can be found looking at First Solar (FSLR) from 2/11/2013. Let me first start by saying that while FSLR is not a penny stock it has pretty high volatility. I selected FSLR for this example as a means to show how a trending stock would respond to this sort of pattern.

First we will want to identify the cup pattern. The cup pattern will need to have taken place the previous trading day. The larger the cup, with light volume the better. In the FSLR example you will see that the chart set the high of 30.80 (H1) at 9:40. From this high the stock floated down to a low point of $30.04 (L1) at 11:10 am and then drifted higher into the close. You will notice that the entire day had light volume. The stock also floated above and below the 35 simple moving average which is another indication FSLR was in a sideways pattern.

As we move on to the next trading day, 2/11/13, FSLR opens up in a choppy pattern for the first 10 minutes then begins to move higher with volume. In three minutes 9:40 – 9:42 the stock had a sharp 2.2% move higher. This breakout would have marked your entry point for the cup breakout strategy. Remember we need a breakout with volume that is .35% above the previous day’s high. This would have resulted in an entry point of $30.90. After a sharp move to the first swing high of $31.18 (H2) FSLR has a sharp pullback to the breakout range from the morning. The pull back did not hit the 35-day period moving average and the stock had another run to $31.67 (H3). From H3 FSLR begin to drift and the volume dropped off significantly. At this point based on the rules laid out by Mr. Calhoun the exit point would have occurred at 10:35am at the price point of $31.39.

Advanced Technique – Analyze Market Internals

One of the advanced techniques for trading the cup breakout system is to include market internals in your analysis. It is not required to enter the trade, but if the larger market is also breaking out to new two-day highs in the first hour this can add additional support to your position and reduces the odds that your stock will having a morning reversal.

Review of the Day Trading Cup Breakouts Strategy

Pros

The day trading cup breakout system keeps it simple with straight forward rules and only one indicator to follow (moving average). The system relies on volume and price action which are the oldest technical indicators you will find. Using the 1-minute chart is a great way to limit the risk of trading during the first hour of trading which is the most volatile time of the day. Lastly, the system uses a moving average as the exit which makes sense because high volume breakouts likely lead to trending markets.

Cons

The day trading cup breakout system does not provide a clear stop when the trade goes against you other than a cross of the moving average. If going into the breakout the price action is far above the price, you may end up exiting will below your entry point if the stock goes against you. While the first hour of trading provides the greatest chance for profits, it also presents the potential for risks. The other part of the system which I would find challenging during execution is the skill to know when the breakout has enough legs that using such a lagging time period of 35 periods will net consistent gains. I personally like to sell into strength with predetermined targets.

Video Example of a Day Trading Cup Breakout

The below video breaks down another working example of the Day Trading Cup Breakout.

Transcript of Day Trading Breakout Video

Hello everyone this is Al Hill, co-founder of Tradingsim.com. To simulate the lesson that we are going to cover in this video visit tradingsim.com or give us a call at 888.610.2734.
Hello everyone this is Al Hill from Tradingsim.com. Today we will be discussing the day trading breakout cup strategy ass presented by Ken Calhoun. Before we get started you will need to configure your chart in order to size up the trade. First you will want to adjust your chart to a 1-minute time frame. Secondly you wil want to select a simple moving average of 35 periods. Third on your list you will want to add volume to your chart. At this point you are now ready to trade the market with this pattern. So, in this example here let’s pause it for a second. On February 11th if you look at this chart FSLR in the afternoon had a pretty flat day. The stock began to drift sideways here. Now when you see a number of cup patterns repeating themselves that is a clear indication you are in a sideways market. You will see the stock begins to just go up and above the 35-period average without a care. So here you will see the volume is somewhat higher here on this bar which is the start of the cup and the high of this bar is $32.58. The stock then goes into a lull and makes a low here and then comes out of it here. You will see the volume start to pick up in here. At this point the stock makes a handle which is this tight formation here. The handle is another way of saying a flag if you will. So at this point you have the actual formation, the cup formation from the previous day . You have a high of $32.58. So based on Ken Calhoun’s method you will want to buy the breakout of the previous day’s high which is $32.58 within the first hour of trading and it has to come with higher volume and it has to be .35% higher. You can see the volume is coming in here with First Solar. We will want to buy a break of $32.69. Alright so let’s skip forward to see how that would have played out. As we skip to midday you will see the stock broke out with volume. You will see it here. $32.69 was exceeded within 2 minutes of the open. FSLR then just kind of went up made another high came back down tested the 35-SMA and here it actually closed below it. So, here is where we would have exited the position at $33.07. In this example of First Solar it went higher, but this is the market it could have just as quickly gone lower. This is the day trading cup breakout strategy. Please visit Tradingsim.com to simulate this lesson. Thank You.

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The bottom tail formation is a trend reversal pattern that comes at the end of a down move.  Below is the setup for the bottom tail pattern:

1. There is a downtrend in progress
2. Select two popular time frames that are close together (i.e. 1-min & 5-min or 5-min &15-min)
3. Identify a bottom tail candle on both time frames
4. You will want to enter the trade on the break of the high of the bottom tail candle
5. Enter your stop below the low of the bottom tail candle

What is a Bottom Tail?

A bottom tail is a candlestick that has a long wick and small body. If you were to dissect the body of the candle there was increased selling pressure which resulted in the long wick, followed by a strong rally that left the stock closing very close to where it opened. The bottom tail will reveal itself after an established downtrend and is one of the first examples that the bears are losing control and the trend is shifting to a more neutral state.  Below is an image of a bottom tail.

For those of you reading this article that do not have a lot of experience with trading candlestick formations, these formations are another version of a technical indicator.  Some in the industry will lead you to believe that simply identifying the key patterns will lead to instant wealth.  Instead of looking to candlesticks as the magic bullet, these formations are great when combined with other confirming signs.  This rule of looking for confirmation in other indicators is always a great idea to validate your beliefs.

Specifically for the bottom tail formation we are going to use the price action on multiple time frames to confirm a reversal in trend.  The power of using multiple time frames is on an intra-day basis when traders on different time frames see the same thing, this confluence can result in great trend reversal opportunities.  Think about it.  If both traders on a 5-minute and 15-minute bar both see a buy signal, you now have more participants taking action at the same price level.  This will increase the amount of activity which is required to generate a reversal of trend.

For the analysis covered in this article we will use the 5-minute and 15-minute charts.  When comparing multiple time frames you will want to focus on (1) the most popular time frames and (2) of these time frames the ones that are closest to each other.  For example you would want to pair the 15-minute with the 30-minute, or the 1-minute with the 5-minute.  The expectations for gains should be in direct proportion to the time frame you have selected.  It’s not good form to expect the same level of price swings on a 1-minute chart as you would on a 60-minute.

Bottom Tail Example – Goldman Sachs

In this first example we will be looking at a bottom tail formation for Goldman Sachs from 8/10/2012.  Can you identify the bottom tail pattern in both the 5-minute and 15-minute charts below?

Did you pick the right tails?  So for the 15-minute bar the bottom tail showed up on the print of the 2:15 candle.  For the 5-minute bar the bottom tail revealed itself on the print of the 2:20 candle.

Notice how both candles have longer wicks and smaller bodies.  Also, do you see the display of downward pressure from the number of red candles preceding these lows?

Now comes the fun part.  Where do you think you should enter the trade?

For the more aggressive trader you will enter a break of the bottom tail’s high on the 5-minute bar.  The reason being the high from the 15-minute bar is likely to be greater than that of the 5-minute bar because it is on a longer time frame.  For those of you that want additional confirmation the trend has a greater chance of reversing you will want to enter on a break of the bottom tail’s high on the 15-minute bar.

Stops

In terms of stops you will want to place your market order below the low of the bottom tail bar.  Another option is to place your buy order on the 15-minute scale and your stop market order on the low of the 5-minute bottom tail.  This way you can be slow a.k.a conservative to enter the trade, but quick to kill the position if it goes against you.

Profit Targets

For profit targets you will want to either sell into the strength or use a moving average to exit your trade.  For example, if there is a gap above that the stock is now going back to fill and you see climatic volume coming in you will want to exit at that point.  Another option would be to apply a moving average (i.e. 10, 20, etc.) to the chart and then close out your position once the stock closes beneath the average.

Pros of the Bottom Tail Day Trading Strategy

The bottom tail buy strategy combines both candlestick patterns with the concept of time – traders on two different time frames.  The entry points and exit points are straight forward.  You can apply this strategy to any security and you can use it on multiple time frames

Cons of the Bottom Tail Day Trading strategy

It is tough to find a bottom tail on both the 5-minute and 15-minute bars unless you have a real-time stock screener.  Since the stock is trading in real-time and you only have minutes to identify the trade, you have to quickly scan the market for bottom tails on both time frames simultaneously.  This would be a simple task if you were looking at daily/weekly charts, but is far more challenging an an intra-day basis.

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The three bar patterns is one of the more common trading setups.  The reason its so common makes it an easy target for newbie traders when they do their scans.  The problem with the three bar reversal pattern when it comes to day trading is the setup can be found all over the place.  So, in order to reduce the potential number of trades on an intra-day basis, we are going to apply a few requirements to this setup to filter out the noise.

1. The stock must be trending hard in one direction
2. The low or high of the three bar formation must occur on the middle candlestick
3. The third bar must close above the high of both the first and middle candlestick (the requirement of the formation is only that it closes above the high of the middle bar, but we are tightening this rule a bit to increase the odds in our favor)

As  you see the picture below you will notice the painfully obvious the trend has reversed based on the closing of the third bar.  That’s the entire point, we want to have a clear sign that the trend has reversed in order to reduce the number of false signals.

Example of when a Three Bar Reversal Pattern works

Let’s first establish a baseline of when the three bar reversal pattern works.  For this example since we are day trading we will use the 5-minute time frame to identify the setup.  The below chart is of First Solar (FSLR) from 2/20/2013.  The stock made a low and then reversed sharply.  The third bar in the formation closed above the high of both the middle bar and the first bar.  Again, the three bar reversal pattern only requires a close above the high of the middle candlestick, but we are looking for a close above the first and second candlestick for insurance.  In this particular setup, you would have purchased FSLR on the close at $36.03 which was 1 penny above the high of the first candlestick at $36.02.  While the three bar reversal pattern does not have a specific exit trigger you can use a simple moving average or a price target to book your profits.  A guiding principle is you want to maintain a 3 to 1 risk to reward ratio for all of your trades.

Let’s have a little fun and stretch the boundaries for the setup.  What if instead of simply identifying the setup on one day, what if we look for setups that occur over a two-day period.  This way we can honor the rules as defined for the three bar reversal, but wait for the third bar to occur on the next day.  This way you can take advantage of the increase in volume and volatility that occurs on the open.

In our next example we will review a three bar reversal pattern for Royal Gold (RGLD) that developed over 2/20/2013 and 2/21/2013.  You will see from the image RGLD had a gap down in the morning, traded flat for most of the day and then closed near the low.  Then the stock had a gap up in the morning to close above the highs for both the first and second candlestick.  This then triggered a rally of over 2% by 10am once RGLD exceeded the high set on 2/20/2013.

False Buy Signals using the Three Bar Reversal Pattern

Day trading is really a test of wills as of late with the number of active participants trying to fake each other out on a daily basis.  The three bar reversal is not immune to these games.  In the next few examples we will cover false signals of the three bar reversal pattern and how you can quickly cut your losses.

One reason the three bar reversal pattern will have a number of failures is due to the lack of volatility.  When the market is really choppy the formation is nothing more than a pause in the action that does not result in any major upswing.  For example, if we look at RGLD from 2/7/2013 you will quickly notice the stock was range bound from 10:30am until the close.  At 1pm RGLD presented a three bar reversal pattern after a minor pullback.  The third candlestick then closed above the high of both the first and middle candlestick.  This gave the impression that a rally was brewing.  Well two small dojis later and the stock rolled over.  At this point you as a day trader have to acknowledge you are on the wrong side of the market.  You will want to place your stop below the low of the middle candlestick.

Pros

The three bar reversal pattern can be easily found on the chart and can generate quick returns.  As a day trader you will have no trouble finding these patterns in any type of market.  Also, unlike other trading setups which are more prevalent in the morning or afternoon, you will find the three bar reversal pattern throughout the day.

Cons

The three bar reversal pattern used by itself can generate a number of false signals.  Adding in additional confirmation items such as volume and volatility will increase the odds the market will go in your favor.

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price-and-volume from Tradingsim on Vimeo.

Price and volume are the oldest indicators you will find in the market.  As day traders we are always looking for an edge, hence the endless supply of indicators and trading methodologies.  When you really boil it down to its root, trading is nothing more than capitalizing on the imbalance of supply and demand.  So, if your screen is cluttered with a bunch of indicators all saying different things and you feel completely lost, then you have landed in the right place.  In this article we will cover the day trading strategy of how to effectively use divergences with price and volume to beat the market.

What to look for with Price and Volume

1. As price moves in the direction of the primary trend, volume should accompany the security with each successive new peak (bull market) or trough (bear market).
2. Each counter move to the primary trend should do so with lighter volume
3. Once the volume for a counter move matches or exceeds the last swing high or swing low of the primary trend, this is a clear sign a potential reversal is in play
4. Just to confuse you a little, there is one exception to the above rules.  For example, if you are in a bear market with a clear down trend line that contains each rally it is ok for each successive touch of the trend line to have heavy volume, as long as this is a sign of selling pressure.  Meaning as the stock hits the down trend line and then moves lower, volume should pick up as sellers short the stock and weak longs use it as an opportunity to unload their shares.

Confirming Primary Trend

An oldie but goodie for traders to identify the primary trend is to overlay one of the many moving averages over the price chart. What if you could use an off chart indicator to do the same thing, but with more confidence.  The problem with moving averages is you will get out of the trade when the stock has closed below the moving average.  What if you could know going into a rally that it’s time to sell on any weakness.  Instead of using a lagging indicator such as simple moving averages, you can use volume as a leading indicator.

In the above example of Bank of America (BAC) from 1/28/2013 and 1/29/2013 you can clearly see the stock has an established down trend on the 15-minute chart.  In point A above the high was made with 11M shares traded.  Then as you can see points B and C both were made with lighter volume.  Finally point D had an almost 200% increase in volume.  So, how would you trade this setup?  Point A and B are purely points that you observe since these establish the downward sloping trend line.  Point C would have been your first opportunity to short BAC.  You would want to see how the volume comes in on the candlestick and where it closes before you open a position.  After point C the stock began to slowly rollover and the volume began to pickup as the stock went lower.    At point C At point D, there are a couple of triggers that would have prompted you to exit the trade if you hadn’t already.  (1) BAC closed above the down trend line and (2) the volume was significantly higher on the breakout candlestick.

The above Wynn Resorts (WYNN) trade from early October 2012 illustrates how price and volume can tell a story as the stock fluctuates between highs and lows.  You will notice on the left side of the above chart WYNN was experiencing heavy volume as the stock (1) tested the down trend line or (2) dipped into a swing low. The low and volume which has a green circle around the action is the first time in this down move where the volume began to dry up.  This would have been your trigger if you were long to either book profits or tighten your stops.  The stock then went flat for and ultimately jumped the trend line on heavy volume.  Assuming you exited the short trade when the stock started to drop on lower volume, now would be the time to load up once the stock pulled back to the trend line.  This was safe entry since the stock pulled back on light volume.  You would have received confirmation on the trade once you saw it break the most recent high with high volume.  This shot the stock up from the $113s  all the way up to $118.98 by 11:15 am.

In our last example we will be looking at FSLR from August 2012.  The stock was in a clearly defined up channel.  As the stock made higher highs within the channel, this price action was also accompanied with high volume. This pattern held true on the 15-minute chart for over a week.  You could have bought the pullbacks and quietly rode the stock higher.  As you can see from the chart above FSLR finally broke down through the support line and then followed this break with a sharp gap down.  Well was that gap down really a surprise?  Of course not, the smart money’s intentions were clear in the tape. As you can see when the stock broke through the bottom trend line it did so with increased volume.  After the break the stock drifted sideways or as we call it in the trading world developed a bear flag.  If you were day trading FSLR you would have had about 5 hours after the break of the trend line to exit the trade.

Pros

If you use price and volume it reduces the noise of the market.  Instead of reacting to every down day as if it’s the end of the world, this will allow you to put things into perspective.  You will know that while your stock may have pulled back, if it did so on 80% less volume, the primary uptrend is likely to continue.  You will also be able to anticipate when a strong market has weakened.  So, in the future you will be able to spot the weakness exhibited by FSLR in our previous example prior to the gap down.

Cons

Analyzing price and volume while day trading requires you to make quick decisions.  Problem with this method is unlike other indicators that may hit a certain overbought or oversold level on an indicator, you have to review and assess price and volume action quickly and accurately.  Again, price and volume is very subjective, so it’s not an trading methodology for the newbie trader.

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A breakout of a range presents an opportunity to get long or short.  But how do you know when the range has enough “juice” to generate a trending move.  As day traders you will have a slew of data to analyze in a short amount of time.  So, why not take the simple approach and instead of looking at ranges that go back 5 or 10 days, simply focus in on the most recent high and low trading range from the previous day.

When you think about it, every stock has its own trading fingerprint.  This is because there are different market operators trading in stocks throughout the day.  But if you peel back the onion, you will notice that the bulls and bears begin to establish clear boundaries of how far they are willing to let a stock go in either direction.  Your job is to simply monitor these ranges and then buy or sell short when the range is exploited.

Requirements for the Two-Day Range Breakout Strategy

1. Identify the price range of the previous day (High – Low)
2. Look back 2 days to see if the range for the previous day deviates greatly from the range set 2 days ago.  You want to avoid a situation where the ranges are completely erratic and a break of the range means little.
3. Buy or sell short the stock once the current day’s range breakout exceeds the previous day’s range by 10%.
4. Use a simple moving average to stop yourself out of the trade.  Logic here is you are buying or shorting the start of a new impulse trend, so you want to go along for the ride.  Another strategy would be to sell the stock out as you approach a predetermined price target.

In this first example we will review First Solar (FSLR).  The previous day’s range on 11/5 was .92 cents.  In order to make sure we are not going to get head faked, we went back one additional trading day to 11/2 and noticed the trading range was $1.33.  With the stock trading currently in the $20 dollar range the delta between the ranges does not give reason for concern.  Now turning our attention back to the current trading action of 11/6, the stock set a  low of $23.25 on the first 5-minute bar and then quickly began to rally.  So, we now would need to set our target entry point for the stock.  Since the previous day’s range was .92 cents we will want to buy or sell short a breakout above a range box of $1.01 (.92 cents x 1.10%). Based on the low set at $23.25 we would look to enter the trade on a break of $24.26 ($23.25 + $1.01).
As you can see from the above chart once FSLR broke through $24.26 the stock took a quick breather and then resumed her uptrend until reaching a high of $25.28 or nearly a dollar of profit.

Can you recognize what in this trade would have given you confirmation that the breakout was real?  Well if you don’t see it, take a look at the volume indicator near the bottom of the chart.  Notice how the stock began to have an increase in volume as the price moved higher.  This was a clear sign that the buyers were pushing FSLR higher and the stock had legs.

In the next example we will analyze Royal Gold (RGLD).  The stock set a trading range of $1.18 on 12/11.  Just as a sanity check we went back an extra day to 12/10 to validate the range is not exponentially larger.  While the 12/10 range was greater, it is not a matter of concern with the stock trading in the 80s.  So now that we know our previous day’s range was $1.18 we apply our 10% lift for a target of $1.30.  This basically means that if the stock’s price moves above or below an intra day range of $1.30 we want to open a position.

RGLD starts out the 12/12 trading day with a gap up only to see the stock reverse lower.  Now at this point you do not know if you are going to go long or short the stock.  RGLD then stops dead in her tracks around 11am, which is a common reversal time and begins to move higher.  Now that we have an established low from the morning of $81.79 you will want to place your buy limit order above $83.09.  This is also a great entry price because it places your order behind the whole number of $83.  As RGLD approached and sliced through the $83.09 level you will notice that the volume picked up on the chart.  Remember this was our extra piece of confirmation from our previous example with FSLR.  Another promising point with the volume is the increase came during the middle of the day which is normally a pretty dead time in the market.  This implies that the stock had real potential and would likely move higher throughout the remainder of the day.

RGLD began to flag after the breakout above our entry point and then had another late day surge up to $84.  Depending on your strategy you could have exited at the next dollar level of $84 or stayed long through the remainder of the day until your moving average of choice was violated.

Pros of Day Trading a Two-Day Range Breakout Strategy

1. The strategy takes into account volatility which I think so many day traders simply ignore.  If a stock has a trading range of $2, why would you enter a trade with an expectation of a $10 dollar move?
2. The entry levels are somewhat hidden.  Unlike other strategies where you buy the break of the previous day’s high, this strategy is based on the box ranges and less about obvious high or low price points.  It also helps that it requires you to wait for a move slightly beyond the previous day’s range to give you confirmation.

Cons of Day Trading a Two-Day Range Breakout Strategy

1. With day trading, every cent counts towards your bottom line.  Waiting for the confirmation may prove a conservative approach against potential head fakes, but if you are consistently right on your picks, over a few hundred trades these forfeited insurance points could add up to big money.

Author information

Alton Hill

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Day trading requires you to have quite a bit of cash on hand for your trading activities.  Margin aside, I have said you need 50 to 1 cash to monthly expenses ratio.  There is a little bit of room here if you have other means for income to offset your expenses, such as rental income.  No matter what you d,o you will still require cold hard cash to be a success.  When you really think about it, making money is the most important thing to focus on as you start out in your trading career.  It’s not about picking the right stocks or placing one hundred trades per day, it’s just about making more money then your expenses.  In this article I am going to cover 5 ways you can go about getting the seed money required to start day trading for a living.

1. Save the Money Yourself

Good luck with this approach.  On paper it makes a lot of sense.  You are using your own money, so you won’t have to answer to anyone.  You are exercising an enormous amount of discipline by consistently placing the money aside each month.  More importantly, you are showing you have the patience required to succeed, because most day traders when presented with cash will tell you they can make the money in the market quicker than they could save it on their own.  The one major flaw in this approach is unless you are an executive in corporate America, to save the amount of cash required and still handle all financial hurdles life throws at you is a pretty daunting task.  To make this example real, if a person’s monthly expenses are 4,000 a month they would need to have $200,000 in cash.  If you think $200,000 is too much money, that’s fine, we just will have to agree to disagree.  Now, back to our example, if this person makes 100k a year that means after tax they will likely take home about 75k depending on their tax bracket.  If we subtract their expenses ($48,000 per year) from their take home pay ($75,000 per year) this leaves them with $27,000.  This of course would not account for any of life’s curve balls (loss of employment, medical bills, new additions to the family, etc.)  At this pace it would take the aspiring trader ~ 7.5 years to save up the required seed money.  Mind you, this trader has not saved one cent towards retirement.  How many people do you think will honestly be able to make it this route?

2.  Use Credit Cards

If you read the book market wizards or some of the rags to riches stories from the street, you will undoubtedly hear of a trader that took 5k on credit cards to 1 million in a few years.  To be honest with you, these stories get me going.  Like most traders its in our nature to cheer the underdog that comes out of nowhere and makes it.  While hearing these stories may get the blood flowing, the odds of them being grounded in truth are pretty slim.  Day trading alone is a hard enough business to succeed in;  couple that with the fact you are now using money that you don’t have, the odds just go that much further against you.

Let’s assume you go for broke and take out $100,000 dollars in credit cards.  Your current monthly expenses are $2,000 dollars so you feel comfortable with the idea you are within my prescribed 50-to-1 cash to debt ratio. The one problem here is off the top if you are using credit cards there will be a minimum monthly payment requirement.  On $100,000 that minimum will run you a cool $2,000 dollars (2% of outstanding debt).  So, the monthly expenses have now just gone up 100% to $4,000 dollars.  At this point you will need to make 4% return per month just to survive.  Oh wait, you will have to pay some taxes of course, so that percentage has just jumped up to 6% per month.  The last whammy I will throw your way in this scenario is if you lose any money.  Unlike when you use cash, you still have to not only pay the interest on the money, but also have to repay what you have loss.  This has a compounding effect on your trading capital.  I think you get my point, do not use credit cards to fund your trading activity!

3,  Take the Money out of your Home

This was the obvious go-to during the bull market in real estate.  The sudden found wealth in people’s homes provided the means to kick start a number of trading careers from 2003 – 2007.  Using equity from your home will provide a much better interest rate than a credit card, but the one problem with this approach is your home is used as collateral.  In a worst case scenario if you lose your stake not only are you out of the game, but you also may lose your home.  Again, much like credit card debt, the use of a home credit line will increase your monthly expenses and further compound your losses if things don’t go as planned.

4.  Borrow from Family

Trading is a journey best taken alone.  If you accept money from your parents and they are unable to completely stay hands off with the management of the money this will prove to be a headache you can’t escape from.  You now have introduced for lack of a better term a partner into your trading venture.  Yet, this partner has not taken the time to research the markets or attempted to understand the mechanics of your system. They are just there to point out when things aren’t going well and a constant reminder of their discomfort and the veiled threat of pulling the funds if you don’t make money everyday.

5.  Trade Your Way to the Top

This is more of an old school way of getting the start-up money required to start your career.  Simply put, if you want to trade in the markets, what better way to get the initial capital required other than trading the markets. Other than your time and sweat equity the market in theory should be an endless A.T.M. at your disposal.  This is honestly my favorite means to get started.  First off you are not committing any additional money from savings until you have proven you can make money trading.  Secondly the money is all yours.  You have not borrowed it from anyone and you do not have all of the pressures that come with not controlling your own destiny. Last but not least you are building the self confidence that you can actually pull off the wild idea of making a living trading.  The major downside to this approach is it will take years before you are able to trade full-time.  But like any profession worth mastering you must be prepared to commit to 10,000 hours of study before you can truly call yourself an expert.

What of the 5 options above would best suit your risk profile?  As my Dad has told me over the years, most of the time in life the option which is the most painful is often the one built on a solid foundation.

Author information

Alton Hill

I am one of the co-founders of Tradingsim and an IT consultant who specializes in large scale Systems Integration projects. I have traded the markets actively since 2000 and believe that true trading mastery comes from practice . When I'm not working on a new day trading strategy, I enjoy spending time with my wife and 3 young sons.

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When you get up every morning to go to work you know what hours your employer expects you to work.  What about your favorite store.  For me it’s a toss up between Best Buy and Wegmans (I know a grocery store).  Even though these two establishments would gladly take my money, they will only do it during business hours.  The point I’m getting at is every business has a way they conduct their business.  These range from hours of operations to product pricing.  In this article we will cover a strategy where you only place 3 trades a day with a set profit target for each, so you can achieve the same level of structure Fortune 100 companies follow.

Trading is not an activity that requires an enormous amount of effort.  If you like to constantly fight people in life, you will likely put on a lot of trades and make very little money.  You on the other hand may be the constant dreamer, looking to hit it big (we also like to call this a classic gambler in certain circles).  What if you turn down all of the noise in the market.  When I say noise I mean the tips, indicators, complicated trading programs and even your own thoughts.  Whether you are a breakout trader or automated system trader, it doesn’t matter.  The 3 trades a day strategy can work for any system.

Why 3 Trades a Day?

It’s an odd number, so you can quickly see whether you were able to pick more winners than losers on a given day.  It allows you to put on enough trades over a one-month period to make some serious cash (see below).  It provides you a clear point to which you need to halt all trading activity for the day.  How many of you have experienced a flash of over trading?  How much damage did you do to your account?

As a child I was an avid bowler.  There was nothing better than waking up every Saturday morning and going down to the bowling alley.  The best part of it all is I knew I only had 3 balls per turn (duckpin bowling) and the maximum score I could bowl in any one game was 300.  Every week my average was updated based on my 3-game set.  So, I knew how well I had improved from the beginning of the bowling season at years end.  Why in trading do you not measure yourself as closely as I measured my bowling when I was 9?

Lastly only placing 3 trades forces you to focus on your strategy.  You will know before you place a trade that you only have 2 more you can open for the entire day.  This will force you to be more critical of entering a new position.  Remember, it should always be really hard for you to open a new position, but you should always quickly pull the trigger when profits present themselves.

Do you know how much you will make this month?

In business, over time you begin to develop trends.  As a retailer you will know your peak seasons as well as the average amount of sales you can expect to generate in a year.  There may be some variations, but for the most part your actual results will be within a certain percentage of your baseline estimate.  Traders on the other hand hate the idea of earnings targets.  You want to feel that the market is limitless and there are no boundaries.  This may trigger a lot of excitement, but let me share a different approach.  Let’s assume you have $100,000 dollars to trade.  If you are a fan of this blog you will know that you can use $40,000 per trade.  Now, assuming there are 20 trading days per month on average, if you place 3 trades per day, that gives a total of 60 possible trades.  At this point it’s just basic math.  In order to use the 3 trades a day strategy, you must have a set profit target and a clear stop loss level. If you are a trader who lives by touch and let’s their profit runs and losses balloon, then this is not the strategy for you.  Reason being, like bowling you need to know how many turns you have per month and what is your definition of a perfect score in order to rate yourself.  Let’s assume your system has a profit target of 1.5%.  This would give you a potential profit of $600.  If you place every trade successfully this gives a high end profit target of $36,000 for the month.  Please do not just skim over this example because it appears simple.  Ask yourself, do you have a earnings profit target for the month?  Please don’t consider the I want to make “x” amount as a real answer.  Do you have a realistic blueprint for how much money you want to earn?

Tracking your Results

Since you are now ready to treat day trading like a business, let’s map out a mock trading month earnings target.

Earlier in the article we stated the target high range for the month was $36,000.  If making 36% return in one month is not enough for you, then please stop reading this article and book a one-way ticket to Las Vegas.  Now that we have made that disclaimer, for the low end you will want to take a third of your high-end target.  This leaves you with a total earnings potential range of $12,000 – $36,000. At the end of the month take your actual earnings and compare those against your target.  So, let’s say you earn $20,000 for the month.  $20,000 would represent 55% of your target.  Unlike school where a 55$ is failing, this would be a passing grade for the 3 trades a day strategy. The bare bones of what you should shoot for is 50% of your high-end target each month.  Since you are placing the same amount of trades every month, like my bowling average as a kid, you need to start tracking your percentage every month.  If you are able to stay above 50%, welcome to the club, if you are able to stay on average above 75% over a 12-month period you are a master trader.

In summary the 3 trades a day system forces you to box in your trading activity. This provides you a clear measurement of how to track your performance so you don’t fall victim to the greed and plethora of opportunities the market presents on a daily basis.  If you don’t believe over trading is a problem, perform this simple analysis.  Look at your trades over the last year.  I guarantee you will see some sort of trend.  For some of you your profits may come in the morning.  Others your profits may pickup after 2pm.  Making money in the market is not about sheer effort, but more about seizing the right opportunities and knowing when to quit when you are ahead.

Author information

Alton Hill

I am one of the co-founders of Tradingsim and an IT consultant who specializes in large scale Systems Integration projects. I have traded the markets actively since 2000 and believe that true trading mastery comes from practice . When I'm not working on a new day trading strategy, I enjoy spending time with my wife and 3 young sons.

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When should I sell my stock?  If you have been trading for less than an hour you have probably already asked yourself this question.  If we figure out the old adage of buy low and sell high, we could all live the good life.  Trading however is a bit more challenging.  There are indicators, systems, tips and a plethora of other options that present a rationale for selling your position.  Which one do you use?  In this article we will cover a simple means to know when to exit your position.

As traders we have price targets in mind before we enter a trade.  While we will never admit it, on some level we expect the stock to make a b-line move directly towards our target.  For new traders the level of excitement when entering a trade is about as close as you will get to reliving your 5th birthday.  Unfortunately, the majority of the time the stock does not behave appropriately.  At this point your emotions will start to pick up.  You start to say things like to yourself like: “Do I sell, do I wait?  I have made some money, why am I being greedy?  My favorite stock guru told me it would go higher, so I just need to wait.”  Once you start thinking in an unsure manner, please pack it in and stop trading.  The market does not require you to always be right, but it does require you to have strict rules and confidence in what you are doing.

Time – the Missing Link

Make sure you are reading this closely.  It’s so simple you may miss it if you are day dreaming.  The key to knowing when to sell is to factor in the element of time and volatility.  We are not going to cover volatility in this article, to read up on this topic please visit one of our most popular posts How to Trade Volatility; Back to time.  When people trade they just don’t think in terms of time.  It’s funny in a way.  We really only think of money but not the amount of time required to make the big bucks in the market.  In any other profession, you have the concept of a timeline.  You will say to yourself that you need to start at the bottom, make manager in 7 years, director in 15 years and senior vice president in 25.  You understand that things don’t happen overnight and this helps you weather some of the rough times.  You don’t just say to yourself, I’m out of here.   Well maybe you quit one or two jobs if the promotions aren’t flowing, but at some point you realize you can’t keep bouncing around, because who is going to want to hire you.  Trading is the same way and I’m going to show you why.

When Should Pete Sell His Stock?

Pete is a fictitious character, so please don’t try to Google him.  Pete is a day trader.  He has a system that requires him to make 1% on each and every trade.  Pete read up on Tradingsim’s article about volatility so he knows how to scan the market to find trades that fit his trading profile. While Pete is able to find the right top of stocks he always sells out before his profit target is hit and he doesn’t know why.

In order to bring in the time element to trading let’s take a deep dive into the stock Facebook (FB).  First we will need to build a time profile for Facebook.  Since Pete is day trading, let’s look at the 5-minute chart and we want to determine how long 1% moves have taken to materialize over the last three swing trades.  The reason we are assessing the last three swings is to capture how the stock has been recently performing as an indicator of how things are likely to develop in the near future.

Starting on March 13th, Facebook had a greater than 1% swing range of $27.65 down to $26.92.

This move required 8 candlesticks to play out.  This move also began after a gap down on the open, so Pete should have made a mental note that the move was likely exaggerated.

Next trade, still on March 13th, Facebook then bounced off of the midday low from the morning gap down to form another 1% move ($27.19 up to $27.45).

Facebook then went on another 1% swing from $27.45 down to $27.07.  This move down required 10 candlesticks.

We have now been able to establish 3 clear examples of 1% swings with Facebook.  The three swings required 8, 14 and 10 candlesticks respectively.  The average of these three swings are ~11 candlesticks.  So, looking at this clear picture, if Pete wanted 1% or greater from FB, why would he expect this to happen in 3 or 4 candlesticks?  Have you ever found yourself in this position where you are expecting a stock to move in a certain fashion? Without understanding how long recent moves have taken to develop, do you see how you are walking in the dark a bit?

Before I lose you let’s take this up a level.  You landed on this page seeking an answer on when you should sell your stock.  Since the question is posed in a way that you are long, let me now show you what Pete should do in his next long trade.

Remember there are three things you should know before entering a position.  First you must have a profit target in place, secondly you must know how long it will take to get there and three you must have a stop loss in place when things do not go according to plan.      In Pete’s case he knows that it will take Facebook a minimum of ~11 candlesticks for him to achieve his 1% profit target.  While we have displayed this example on the 5-minute chart, you will find similar patterns, albeit larger ones on higher time frames, but the principle remains the same.

When to Sell if things do not go as Planned

This is the hard part of trading.  When to know to cut your losses or when to cash in when you are no where near your profit target.  Well, let’s go back to our good old friend Pete.  Remember how Pete tracked 3 swings in Facebook from the 13th of March.  The very next day Pete decides to buy a test of the mornings low.  He enters the position believing wholeheartedly that the trade will go his way and he will hit his 1% target.

Pete’s entry point was great.  He waited for the market to test the morning lows on light volume and he had a tight stop below the recent low.  However, the market did not move in the fashion Pete would have expected.  Without having some sort of time expectation, Pete would have no reason to exit the trade prematurely.  The stock reacted positively after he made the purchase and then it began to drift sideways.  The newbie trader waits for the stock to continue higher and ignores the warning signs that something is off.  In this example you could see that Facebook did not make a run higher, but instead rolled over into the close.  Now, I know all of you traders who make decisions by “touch” will say that in other cases the stock could have gone higher.  To be honest, you are probably right.  But in this game of trading where the only measure in my book is how consistently you book profits, Pete should be a-okay with gains slightly below his profit target of 1%.

When to Sell when things go terribly Wrong

Once you are in a trade and things immediately go against you in the worst way, do not hesitate.  Just as Pete has clear targets of how much money he plans to make, you also need to know when to fall on the sword.  Below is an example where Pete was clearly wrong from the start.

Notice how in the above chart the minute Pete put on the Apple trade the stock rolled over and went lower.  As a trader you must have your stops ready to go if you find yourself in this situation.  No matter how long you have been trading or how good you think you are, you must be prepared to cut a loser in a nanosecond.

Do you know when to Sell your Stock?

After reading this article I hope you know when to sell your stock.  If not let me give you a quick recap:

1. Before you enter the trade make sure you have a clear stop loss order if things go terribly wrong.
2. Make sure you have a profit target to exit the trade.
3. Remember to factor in time if the stock initially acts appropriately but then things become a bit gray.  This will tell you when you need to get off the bus.

If you follow those three rules, you should not find yourself in a position where you are questioning when to sell your stock.

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I have written a few articles on trend reversal patterns, but I would like to dive into the topic of buying and selling climaxes when day trading.  The obvious question you probably have is if someone is buying a lot of shares and I am long, this is a good thing right?  Well, it is when the buying is healthy in nature.  However, if the buying and selling are extreme, this is a sign the retail or uninformed trader has entered the market and there is no one left to sustain the current move.

So, why should you care about buying or selling climaxes?  The short answer is you can make money trading this basic formation and you can save money by not ending up on the wrong side of the market.  If timed just right, going in the opposite direction of a climactic move can yield sharp returns.  In this article we will cover real-life examples of buying and selling climaxes.

Psychology behind Buying and Selling Climaxes

Big Money Players

In the market you have the small percentage of traders who make the vast sum of profits.  Then there is the retail or uninformed investors who fund the top 1% of traders’ lifestyles.  The buying and selling climax setup is the greatest example of this redistribution of wealth you will find in the market.  Normally the big market players will accumulate and/or distribute their shares overtime in a healthy manner.  This is because the large players understand if they were to try and offload and/or accumulate large positions in one transaction; it would disturb the natural law of supply and demand.

Retail Investor

Climaxes are nothing more than traps for the average trader.  Buying and selling climaxes are one of the toughest patterns to experience as a uniformed trader. Reason being they generally occur around the time of a major news event.  For example, a company will announce record earnings and everything from the quarterly reports looks great.  Naturally you place an order to buy the stock and for a short time things are working in your favor.  Then just when you begin to get comfortable in your position, the stock will have a sharp reversal and drop like a rock.    This is a demoralizing experience because not only were you wrong in your trading approach, you were dead wrong!

How to Trade Buying and Selling Climaxes

Below are the rules for how to trade buying and selling climaxes:

1. Identify volume increases >300% of the last 5 trading days.  This first rule assumes you are day trading (intra-day charts).
2. Look for a test or break of the demand/supply line (top or bottom of the trend channel).
3. Place your buy order .25% above or below the candlestick (depending on if you are going long or short).
4. Place your stop below or above the high of the opening candlestick (depending on if you are going long or short).
5. The stock can never break the low of the first candlestick if going long and cannot exceed the high of the first candlestick if going short.
6. Close your position at the supply line or a back test of the trend channel

Selling Climax Example

Our first example comes from Facebook (FB) on the morning of January 31st, 2013.  As you can see from the below 15-minute chart Facebook had a clear uptrend that began in the middle of December and ran through January.

On January 31st Facebook gapped down 7% through the channel and the volume was significantly higher. You will also notice how the long-tail candlestick developed on the 5-minute chart.  At this point in the trade requirements 1 and 2 have been met for trading the selling climax.

The first candlestick has a high of $29.36 and a low of $28.74. To satisfy rules 3 and 4 we would place our buy order at $29.43 and our sell order at $28.73.  The price target would be the previous demand line (bottom line) of the trend channel at ~$31.50.  Based on our stop order and profit target the trade provides us a 3-to-1 risk reward ratio.

After entering the trade you will see how Facebook rallied to close the gap in a b-line fashion.

Without these rules in place of how to view a morning gap on high volume you would have done one or more of the following:

1. Sold Facebook short after it gapped down
2. Closed your long position prior to back testing the demand line
3. Failed to book profits after Facebook clearly back tested it’s demand line twice
4. Not placed an initial stop order when you first opened the position

Are you starting to see how the smart money makes money now?

Buying Climax Example

Looking at Facebook, if we go back to October 24^th, 2013 there is a clear example of a buying climax.  Facebook had been in a flat trading range for three months, beginning in mid-July.

Notice the spike in volume that shot Facebook right up to its supply line.  Facebook quickly stalled after the first candlestick. The high of the candlestick was $24.25 with a low of $23.68.  This means our stop would be at $24.26 with a short entry at $23.62.  The potential profit target for this position is $19 which is the bottom of the trading rage.  This represents a risk of .62 cents with a profit target of $4.62.  I don’t know about you but I would take a 7.45 risk-to-reward ratio any day of the week.

Let’s fast forward to see how this trade would have played out.

Facebook in fact pulled back to the demand line (support), at which you would have exited the trade with a handsome profit.

From this article I hope you have picked up on the following:

1. Even though you may be day trading, you should still have some context of the bigger trends to determine if your stock is hitting larger supply or demand lines
2. Some day traders avoid opening positions after the first candlestick (myself included) but given the right circumstances it can be profitable
3. Learning how climax events work, you should avoid the scenario where you enter a trade only to have it fade – immediately resulting in a losing position
4. Clear profit targets of when to exit your position.  Far too often newbie traders will hold onto a position and miss out on booking profits.

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Why Moving Averages are Good for Day Trading

Keeping things Simple

Day trading is a fast game.  You can be up handily in one second and then give back all of your profits shortly thereafter.  As a trader, you need a clean way to understand when a stock is trending and when things have taken a turn for the worse.  When analyzing the market, what better way to gauge the trend than a moving average?  First off, the indicator is literally on the chart, so you do not have to scan anywhere else on your screen and secondly it is simple to understand.  If the price is moving in a particular direction over ‘x’ periods then the moving average will follow that direction.   Unlike other indicators, which require you to perform additional analysis, the moving average is clean and to the point.  In day trading, having the ability to make quick decisions without performing a number of manual calculations can make the difference between leaving the day a winner or losing money.

Should You Go Long or Short?

Moving averages also provide you a simple yet effective way for knowing what side of the market you should be trading.  If the stock is currently trading below a moving average then you clearly should only take on a short position; conversely, if the stock is trending higher then you should enter long.  When a stock is below its 10-period moving average under no circumstances will I take a long position.  I know, I know, all of these concepts are basic and that is the beauty of it all, day trading should be easy.  I have yet to meet a trader who can effectively make money using a million indicators.

Best Moving Average for Day Trading

There are literally an infinite number of moving averages.  There are weighted, simple and exponential and to make matters more complicated you can select the period of your choice.  With so many options, how do you know which one is best?  Since you are clearly reading this article for an answer, I will share my little secret.  For day trading breakouts in the morning, the best moving average is the 10-period simple moving average.  This is where as you are reading this article you ask the question why?  Well, it is simple; first, if you are day trading breakouts in the morning you will want to use a shorter period for your average.  Reason being, you need to track price action closely, as breakouts will likely fail.  Please do yourself a favor and never place a 50-period or 200-period moving average on a 5-minute chart.  Once you find yourself using larger periods this is a clear sign you are uncomfortable with the idea of active trading.  Now, back to why the 10-period moving average is the best; it is one of the most popular moving average periods.  The other one that comes in a close second is the 20-period.  Again, the problem with the 20-period moving average is it is too large for trading breakouts.  The 10-period moving average gives you enough room to allow your stock to trend, but it also does not make you so comfortable that you give away profits.  In the next section, we will cover how I use the 10-period simple moving average to enter a trade.

How to Use Moving Averages to Enter a Trade

So, let me say this up front, I do not use the 10-period simple moving average to enter any trades.  I know, that is completely contradictory to the title of this section, but I think it is important to cover this topic. If you buy the break of a moving average it may feel finite and complete, but stocks constantly back test their moving averages.

Now that the curve ball is out of the way, let us dig into how I actually enter a trade. Below are my rules for trading breakouts in the morning:

1. Stock must be greater than 10 dollars
2. Greater than 40,000 shares traded every 5 minutes
3. Less than 2% from its moving average
4. Volatility has to be solid enough to hit my 1.62% profit target
5. Cannot have a number of bars that are 2% in range (high to low)
6. I must open the trade between 9:50 am and 10:10 am
7. I need to exit the trade no later than 12:00 noon
8. Close the trade out if the stock closes above or below its 10-period moving average after 11 am

If you are like me these rules sound great, but you need a visual.

The above is a day trading breakout example of First Solar from March 6, 2013.  The stock had a nice breakout with volume.  As you can see, the stock had well over 40,000 shares per 5-minute bar, jumped the morning high before 10:10 am and was within 2% of the 10-period moving average.

Here is one more example, but this time it is on the short side of the trade.

This is a chart of Facebook from March 13, 2013.  Notice how the stock broke the morning low on the 9:50 bar and then shot straight down.  Volume also began to accelerate as the stock moved in the desired direction until reaching the profit target.

This is literally the only setup I trade.  I believe in keeping things simple and doing what makes money.  As stated earlier in this article, notice how the simple moving average keeps you on the right side of the market and how it gives you a road map for exiting the trade.

How to use Moving Averages to Stop out of a Trade

In theory when buying a breakout you will enter the trade above the 10-period moving average.  This will give you the wiggle room you need in case the stock does not break hard in your desired direction.  The above chart is the classic breakout example, but let me give you a few that are not so clean.

The above chart is of First Solar (FSLR) from April 10, 2013.  The stock had a false breakdown in the morning then snapped back to the 10-period moving average.  This is your first sign that you have an issue, because the stock did not move in your desired direction.  If your stock fails, the 10-period moving average will provide a fail safe for you to gauge your stock.  Continuing on, FSLR stopped in its tracks at the 10-period moving average and reversed down again only to trade sideways.  At this point, you know that something is wrong; however, you wait until the stock closes above the moving average because you never know how things will go.

How to use Moving Averages to Determine if a Trade is Working

You have to know when to hold them and when to fold them.  If we could all apply this logic to business and life, we would all be much further ahead.  In the market, I think we naturally look for the perfect example of our trade setup.  In reality, the majority of trades will neither work nor fail, they will just under perform.  Since I am trading breakouts, the moving average must always trend in one direction.  For me I know it’s time to raise the caution flag once the 10-period moving average goes flat or the stock violates the moving average prior to 11 am.

Why I Do not Ride the Average

Before I get 100 emails blasting me for this one, let me qualify the title of this section.  Yes, you can make money allowing your stock to trade higher as long as it does not close below the moving average.  For me, I was never able to make consistent sizable profits with this approach day trading.  There was a time before automated trading systems were stocks moved in a linear fashion.  However, now with the complex trading algorithms and large hedge funds in the marketplace, stocks move in erratic patterns.  Couple that with the fact you are day trading breakouts, it only compounds the increased volatility you will face.

So, to avoid all of the back and forth present in the market, I would have a 2% profit target.  On average the stock would have a sharp pullback and I would give back the majority of my gains. To counter this scenario, once my stock hit a certain profit target I would start using a 5-period moving average to try to lock in more profits.  So, it was either give the stock room and give back the majority of my gains or tighten the stop only to be closed out practically immediately.

It was a vicious cycle and I advise you to avoid this type of behavior.  I did not begin to make money in the market until I started selling into strength and covering into weakness.  I discovered that when I would scan the market looking for examples of my trade setups I would naturally gravitate towards trades that were perfect in every sense: clean breakouts, high volume and b-line moves of 4% to 7%.  So, on some level I was training myself on a subconscious level to expect these types of gains on every trade.  This sort of thinking led to a lot of frustration and countless hours of analysis.  Where I ultimately landed and you can see from the trading rules I laid out in this article, was to look at all of my historical trades and see how much profit I had at the peak of my positions.  I noticed on average I had two percent profit at some point during the trade.  I took that a step further and reduced it down to the golden ratio of 1.618 or 1.62% to increase my odds.

Why you Need to Use the Default Moving Average

Technical analysis is clearly my method of choice when it comes to trading the markets.  I am a firm believer in the Richard Wyckoff method for technical analysis and he preached about not asking for tips or looking at the news.  Everything you need to know about your trade is in the chart.  One thing I tried to do early on in my trading career was to outsmart the market.  What I mean by this is I would take for example the 10-period simple moving average and say to myself a simple moving average is not sophisticated enough.  This would lead me down the path of using something more colorful like a double exponential moving average and I would take it a step further and displace it by “x” periods.  If you are reading this and have no idea, what I am talking about then great for you.  What I was doing in my own mind with the double exponential moving average and a few other peculiar technical indicators was to create a tool set of custom indicators to trade the market.  I believed that if I were looking at the market from a different perspective it would provide me the edge I needed to be successful. Well, this could not have been the furthest thing from the truth.  The market is nothing more than the manifestation of people’s hopes and dreams.  To that point, if the majority of people are using the simple moving average then you need to do the same so you can see the market through the eyes of your opponent.  The art of war says it best in Chapter 3, “So it is said that if you know your enemies and know yourself, you can win a hundred battles without a single loss.  If you only know yourself, but not your opponent, you may win or may lose.  If you know neither yourself nor your enemy, you will always endanger yourself.”

Common Mistakes when using Moving Averages

Using Moving Average Crossovers to Enter a Trade

Many moving average traders will use the crossing of the averages as a decision point for a trade and not the price and volume action on the chart.  For example, how many times have you heard someone say the 5-period just crossed above the 10-period moving average so we should buy?  This action by itself means very little.  Think about it, what significance does this hold for the stock?  Don’t you think a moving average crossover of the 5-period and 10-period will mean very different things for different symbols?  I remember at one point I wrote easy language code for moving average crossovers in TradeStation.  I ran back tests on a few stocks and the results where stellar.  I was just sure I had a winning system; then the reality of the market set in.  The stocks began to trade in different patterns and the two moving averages I was using began to provide false signals.  Therefore, needless to say, I abandoned that system and moved more towards the price and volume parameters detailed earlier in this article.

Not Using Popular Moving Averages

Not using popular moving averages is a sure way to fail. What is the point of looking at something if you are the only one watching?  I am not going to beat this one to death since we covered it earlier in this article.

Using more than One Moving Average

As a day trader, when working with breakouts you really want to limit the amount of indicators you have on your screen.  I have seen traders with up to 5 averages on their screen at once.  In my opinion it is better to be a master of one moving average than an apprentice of them all.  If you don’t believe me there was a study published in August 2010 by Ben Marshall, Rochester Cahan, and Jared Cahan that provided a detail analysis of trading profits when using indicators.  The study stated: “While we cannot rule out the possibility that these trading rules compliment other market timing techniques or that trading rules we do not test are profitable, we do show that over 5,000 trading rules do not add value beyond what may be expected by chance when used in isolation during the time period we consider.”  I am not ready to throw out all of the technical indicators in my toolbox based on this study, but don’t try to turn your indicators into the genie in a bottle.

Constantly changing the Moving Averages You Use

There was one point where I tried the 10-period moving average for a few weeks, then I switched over to the 20-period, then I started to displace the moving averages.  This trial and error period went on for months.  At the end of it, how do you think my results turned out?  Do yourself a favor, pick one moving average and stick with it.  Over time, you will begin to develop a keen eye for how to interpret the market.  Remember, the end game is not about being right, but more about knowing how to read the market.

Using Moving Averages to Gauge the Risk of Your Trade

The 10-period moving average is a great tool for knowing when a stock fits my risk profile.  The most I am willing to lose on any trade is 2% and as you read earlier in this article I will use the 10-period moving average as a means for stopping out of my trade.  One thing I like to do is to see how far my stock is currently trading from its 10-period simple moving average.  If my stock is 4% above the moving average, I will not take the long trade.  I cannot go into the position knowing that I am already exposing myself to 4% worth of risk, which is double my maximum pain point.

The below chart example is from NFLX on April 23, 2013.  Some of you may look at this chart and think wow, the stock is up 22% and on high volume.  For me when I look at Netflix all I see is a stock trading a full six percent away from its simple moving average when it was time for me to pull the trigger.  Since I use the moving average as my guidepost for stopping out of a trade this is too much risk for me to enter a new position.  The next time you look at chart, try thinking of the simple moving average as a risk meter and not just a lagging indicator.

Putting it all together

Let’s talk through an entire trade so we can see how to effectively day trade using a 10-period simple moving average.

The first thing you need to determine is the level of volatility you trade in order to establish your profit targets.  Remember your appetite for volatility has to be in direct proportion of your profit target.  For a deeper dive on volatility please read the article – how to trade volatility.  For me I trade breakouts on a 5-minute period with high volatility.

The above chart of United Health Group from 4/2/2013 has all the right ingredients for my system.  There is heavy volume on the breakout.  The stock gives very little back on the first retracement and breaks the high between the time of 9:50 am and 10:10 am.  Lastly, the moving average is within 2% of the stock price, so I am able to give the stock some wiggle room.  Based on this setup should I pull the trigger?

The answer is yes, but I am purposely showing you a trade that has failed.  There are enough blogs out there pumping systems and strategies that work flawlessly.  Breakouts will fail the majority of the time.  You are simply trying to limit your risk and capitalize on your gains.  In this example, the stock broke out to new highs and then reversed and turned flat.  Once you saw the candlesticks start to float sideways and the 10-period moving average roll over, it was time to start planning your exit strategy.  True to my breakout methodology, I would have waited until 11 am and since the stock was slightly under the 10-period moving average, I would have exited the position with approximately a one percent loss.

In Summary

Moving averages are not the holy grail of trading, but if used properly can help you gauge when to exit a trade and also help limit your risk.  The rest my friend is up to you and how well you are able to analyze the market.  If you get nothing else out of this article, remember that less is more and to focus on becoming a master of one moving average.

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