Epiphany Trading - Part I

Discussion in 'Trading' started by irobert, Jun 2, 2008.

  1. irobert


    Day trading refers to the practice of buying and selling financial
    instruments within the same trading day such that all positions will
    usually (not necessarily always) be closed before the market close of
    the trading day. This is different from After-hours trading. Traders
    that participate in day trading are called day traders.

    Some of the more commonly day-traded financial instruments are stocks,
    stock options, currencies, and a host of futures contracts such as
    equity index futures, interest rate futures, and commodity futures.

    Day trading used to be the preserve of financial firms and
    professional investors and speculators. Many day traders are bank or
    investment firm employees working as specialists in equity investment
    and fund management. However, day trading has become increasingly
    popular among casual traders due to advances in technology, changes in
    legislation, and the popularity of the internet.


    Trade Frequency

    Although collectively called day trading, there are many sub-trading
    styles within day trading. A day trader is actively searching for
    potential trading setups (a stock or any other financial instruments
    that, in the judgement of the day trader, is ready to move in price
    with a potential for a substantial profit. Depending on one's trading
    system (game), strategy, the number of trades the trader can make a
    day may vary from none to dozens.

    Some day traders focus on very short term trading within the trading
    day, in which a trade may last seconds to a few minutes. Day traders
    may buy and sell many times in a trading day and may receive trading
    fee discounts from the brokerage as a rusult, as a trading bonus.

    Some day traders focus only on price momentum, others on trend
    patterns, and still others on an unlimited number of strategies they
    feel are profitable. Winning day traders find they must learn to be
    more patient for the opportunity to ride on the strong move, that may
    arise at any moment.

    Day traders exit positions before the market closes to avoid any and
    all unmanageable risks - negtiveprice gaps (differences between the
    previous day's close and the next day's open price) at the open -
    overnight price movements against the position held. Day traders, like
    all traders, have their rules. Exiting before the close is their
    golden rule to be obeyed at all times.

    Other traders believe they should let the profits run, so it is
    acceptable to stay with a position after the market closes.[1] - not
    for day traders. Once you get hit for a 10 to 20% overnight loss, your
    swing or investor trading life will likely be altered forever.

    Day traders often borrow money to trade. It's called margin trading.
    Since margin interests are typically only charged on overnight
    balances, there is no cost to the day trader for the margin benefit.

    Profit and Risks

    Because of the nature of financial leverage and the rapid returns that
    are possible, day trading can be either extremely profitable or
    extremely unprofitable, and high-risk profile traders can generate
    either huge percentage returns or huge percentage losses. Some day
    traders manage to earn millions per year solely by day trading.[2]

    Because of the high profits (and losses) that day trading makes
    possible, these traders are sometimes portrayed as "bandits" or
    "gamblers" by other investors. Some individuals, however, make a
    consistent living day trading.[3]

    Nevertheless day trading can become very risky, especially if any one
    of the following is present while trading: trading a loser's game/
    system rather than a game that's at least winnable, trading with poor
    discipline (ignoring your own day trading strategy, tactics, rules),
    inadaquate risk capital with the accompanying excess stress of having
    to "survive", and/or incompetent money management (executing trades

    Above all, like a world-class athlete, say Tiger Woods in golf, a
    winning day trader, that is, a consistently profitable trader, would
    not think of conducting his or her business of trading without the
    guidance and support of a world-class consultant / coach - to attain
    and sustain day trading mastery and profitability.

    [4] The common use of buying on margin (using borrowed funds)
    amplifies gains and losses, such that substantial losses or gains can
    occur in a very short period of time. In addition, brokers usually
    allow bigger margins for daytraders. Where overnight margins required
    to hold a stock position are normally 50% of the stock's value, many
    brokers allow pattern day trader accounts to use levels as low as 25%
    for intraday purchases. This means a day trader with the legal minimum
    $25,000 in his account can buy $100,000 worth of stock during the day,
    as long as half of those positions are exited before the market close.
    Because of the high risk of margin use, and of other day trading
    practices, a day trader will often have to exit a losing position very
    quickly, in order to prevent a greater, unacceptable loss, or even a
    disastrous loss, much larger than his original investment, or even
    larger than his total assets.


    Originally, the most important U.S. stocks were traded on the New York
    Stock Exchange. A trader would contact a stockbroker, who would relay
    the order to a specialist on the floor of the NYSE. These specialists
    would each make markets in only a handful of stocks. The specialist
    would match the purchaser with another broker's seller; write up
    physical tickets that, once processed, would effectively transfer the
    stock; and relay the information back to both brokers. Brokerage
    commissions were fixed at 1% of the amount of the trade, i.e. to
    purchase $10,000 worth of stock cost the buyer $100 in commissions.

    One of the first steps to make day trading of shares potentially
    profitable was the change in the commission scheme. In 1975, the
    United States Securities and Exchange Commission (SEC) made fixed
    commission rates illegal, giving rise to discount brokers offering
    much reduced commission rates.

    Financial Settlement

    Financial settlement periods used to be much longer: Before the early
    1990s at the London Stock Exchange, for example, stock could be paid
    for up to 10 working days after it was bought, allowing traders to buy
    (or sell) shares at the beginning of a settlement period only to sell
    (or buy) them before the end of the period hoping for a rise (or fall)
    in price. This activity was identical to modern day trading, but for
    the longer duration of the settlement period. But today, to reduce
    market risk, the settlement period is typically three working days.
    Reducing the settlement period reduces the likelihood of default, but
    was impossible before the advent of electronic ownership transfer.

    Electronic Communication Networks

    The systems by which stocks are traded have also evolved, the second
    half of the twentieth century having seen the advent of Electronic
    Communication Networks (ECNs). These are essentially large proprietary
    computer networks on which brokers could list a certain amount of
    securities to sell at a certain price (the asking price or "ask") or
    offer to buy a certain amount of securities at a certain price (the
    "bid"). The first of these was Instinet. Instinet or "inet" (ECNs and
    exchanges are usually known to traders by a three- or four-letter
    designators, which identify the ECN or exchange on Level II stock
    screens) was founded in 1969 as a way for major institutions to bypass
    the increasingly cumbersome and expensive NYSE, also allowing them to
    trade during hours when the exchanges were closed. Early ECNs such as
    Instinet were very unfriendly to small investors, because they tended
    to give large institutions better prices than were available to the
    public. This resulted in a fragmented and sometimes illiquid market.

    The next important step in facilitating day trading was the founding
    in 1971 of NASDAQ -- a virtual stock exchange on which orders were
    transmitted electronically. Moving from paper share certificates and
    written share registers to "dematerialized" shares, computerized
    trading and registration required not only extensive changes to
    legislation but also the development of the necessary technology:
    online and real time systems rather than batch; electronic
    communications rather than the postal service, telex or the physical
    shipment of computer tapes, and the development of secure
    cryptographic algorithms.

    These developments heralded the appearance of "market makers": the
    NASDAQ equivalent of a NYSE specialist. A market maker has an
    inventory of stocks to buy and sell, and simultaneously offers to buy
    and sell the same stock. Obviously, it will offer to sell stock at a
    higher price than the price at which it offers to buy. This difference
    is known as the "spread". It is of no importance to the market-maker
    whether the price of a stock goes up or down, as it has enough stock
    and capital to constantly buy for less than it sells. Today there are
    about 500 firms who participate as market-makers on ECNs, each
    generally making a market in four to forty different stocks. Without
    any legal obligations, market-makers were free to offer smaller
    spreads on ECNs than on the NASDAQ. A small investor might have to pay
    a $0.25 spread (e.g. he might have to pay $10.50 to buy a share of
    stock but could only get $10.25 for selling it), while an institution
    would only pay a $0.05 spread (buying at $10.40 and selling at