I was reading an article today which maintained it is not possible to make money day trading. Naturally this piqued my interest because I day trade for a living and last time I looked I was doing OK.
The article began by making the very valid point that the vast majority of day trading articles are not written by traders at all, but rather they are written by people marketing systems with hypothetical track records created with the benefit of hindsight.
That is absolutely true.
It is equally true of articles about every other trading style in commodity futures, stocks, forex and options. Whether it is covered calls, trend following with our extra special absolutely never seen before new indicator, swing trading, pairs trading, spread trading, or selling naked options, or any other style, it will often have a hypothetical track record. The time period of the method being promoted is absolutely irrelevant.
The article quotes CFTC rule 4.41 which every futures trader has seen many times. It says:
"Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown."
This pertinent warning is not confined to day trading systems. It is applicable to ANY trading system in ANY time frame where hypothetical or simulated track records are provided.
You see, most system developers research historical data to find high probability setup patterns. They develop indicators and trading rules to exploit these patterns. There is nothing wrong with that, so long as it is realized that the resulting system is optimized over this data set. The only valid way to test the system is on a completely different, independent set of data. Often a system that looks spectacular on the data the developer was originally working with will fail miserably when applied over a different period or in a different market.
The article went on to say that all day trading systems lose because "volatility in short term time frames is random and prices can and do go anywhere, meaning that if you try and use support and resistance levels they wont help you with your trading signal or help you get profitable market timing. You therefore cannot get the odds in your favour and will lose over time. This is fairly obvious when you consider that the price in any financial market is made by a vast diverse group of traders".
Well, that is quite a statement. The fact is "volatility" exists in any time frame and, by definition, it is random in the time frame considered. Indeed, prices can and do go anywhere, whatever time frame you are looking at.
Support and resistance levels are identified from trading charts. If no time scale is displayed it is impossible for any trader to differentiate between a 1 minute chart, a 1 hour chart, a 1 day chart, a weekly chart or a monthly chart if they are not told which market they are looking at. The fact is all charts, in all time frames, exhibit similar characteristics. You will find trends, ranges and most importantly support and resistance levels. It follows that whatever edge you think you can get from identifying support and resistance levels in one time frame is equally applicable in the other time frames too.
Most successful traders use strategies which either (a) sell support and buy resistance, or (b) buy breakouts through resistance and sell breakouts through support. These core strategies are available to any trader working in any time frame.
The distinguishing feature of the day trader is that (s)he always exits trades before the end of the trading session. No positions are held overnight or over weekends. By adopting this approach the trader minimizes "event risk" which is the chance that some dramatic event will so disrupt the markets that you suffer a major loss. (Stop losses are ineffective in this scenario because the market "gaps" through your stop loss level.)
The REAL drawback to day trading is trading costs.
Say that in some hypothetical market, the typical trading costs are commissions (2 points) and slippage on entry and exit (1 point each). So for each trade, trading costs average about 4 points. Now, if a long term trader typically targets 100 points, trading costs would be 4%. For a medium term trader targeting, say, 40 points trading costs are 10%. But for a day trader, targeting 8-10 points, trading costs are 40-50%! Obviously, if a trader is determined to trade this market, then medium to longer term trading is the only sensible option. It would not be surprising for a trader focussed exclusively on this market to form the opinion that day trading does not work.
Clearly, then, not all markets are good for day trading. If the average market movement is just a few points, the trader will be unable to find short term trades which cover the trading costs. Even where the trading costs can be covered, they often turn what looks like a good system into a poor one. This is because, as a rule of thumb, trading costs are nearly always deducted from theoretical profit in successful trades, and added to the theoretical loss in losing trades. This significantly changes the average win to average loss ratio for the system.
To prosper, the day trader seeks out volatile markets where the the projected trading costs are a small percentage of targeted gains. The Expectancy of the system used, allowing for the impact of trading costs on the average win to average loss ratio, must be positive.
Fortunately, many such markets exist. The rather stodgy forex market, with its high trading costs, is NOT a good example. However, there are commodity markets and many individual stocks which exhibit the required volatility.
David Bennett trades US commodity futures from his home on the Gold Coast in Australia. He provides coaching and mentoring services for people wanting to start trading for themselves. Visit http://www.12oclocktrades.com to read more futures trading articles.
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