Theoretically, intraday trading is all about buying low and selling high within the same day. These opportunities for buy/sell can be for a particular stock, sector, or the market as a whole. The success of an intraday trader lies in identifying and taking the right position at the right time.
However, the reality is much more complicated.
One of the biggest roadblocks that intraday traders have to face is a tendency to get swayed by the market sentiment. While some traders get swayed in the direction of the sentiment, others sway in the opposite direction.
So, if there is a buzz in the market about a particular sector, most day traders are buying stocks of companies in that sector. Some traders participate in the trend and some short-sell such stocks playing against the hype. However, as a day trader, the margin for error is small and a wrong call can lead to losses.
Hence, it is prudent to have a plan to execute your day trading activity and keep close to your investing strategy. This is a day trading plan – a broad framework allowing you to make trading decisions that are well suited to you. Today, we will share some steps to help you create a personalized day trading plan for yourself.
Before we begin, it is important to stress on the fact that no one size fits all. And this blog should be considered as a starting point when it comes to charting your day trading plan. Please conduct the necessary due diligence before venturing into intraday trading. Let’s Begin!
Risk tolerance. This is a common term heard across investing and trading circles. However, what is risk tolerance and why is it important?
Every investment comes with associated risks. So, if you are buying shares, then the price of the share can get influenced by various factors. This includes the country’s economic, social, and political situation, and the company’s performance. If the government makes a sudden policy change affecting an industry or the market as a whole, then the share price will respond either in favor of or against you.
Risk tolerance is about the amount of risk you can take without making emotion-driven decisions. While long-term investors have time to allow the share prices to move up, day traders barely have a few hours.
Hence, before you start intraday trading, ensure that you assess your risk tolerance level.
While on the topic of risks, let’s talk about risk management too. A day trader without a strategic risk management plan is like a deep-sea diver without his gear – he is bound to fail. Risk management is primarily the difference between gambling and intraday trading.
This plan will help you have a bird’s-eye view of the overall risks of your trades and potential losses.
Let’s say that you buy shares worth Rs.10000. The price of the claim is Rs.100, and you have purchased 100 shares. You are expecting the share price to rise. After your purchase, the share price increases to Rs.105. Do you book the profit or wait for it to rise further? It reaches 107. If you sell now, you can book a profit of Rs.700 on your investment.
Should you sell or wait? After an hour or market activity, the share price drops to Rs.104. What do you do now? Sell and book profits or wait for it to reach Rs.107 again and sell? The share price now drops to Rs.101. No point selling it now, right?
By the end of the trading day, the share price nosedives to Rs.60 per share. You finally exit your position at a 40% loss from what could have been a 7% profit.
As you can see in the above example, as a day trader, you have to make these decisions at every moment. If you have several open positions, then wrapping your head around the performance of each share can be overwhelming. This is where risk management comes in.
When you enter a position, determine the risk-reward ratio. How much risk are you willing to take for how much reward? In the example stated above, how much will you risk for a profit of Rs.5 per share? This is helpful in defining a stop-loss position. You also need to determine the take profit position – after how much profit will you exit the position. In the example above, if you had a take-profit position of Rs.5 per share, then you would have sold the shares at Rs.105 and not lost 40% of your investment.
Ensure that you have a risk management plan in place before starting intraday trading.
There are primarily two approaches taken by day traders to create a trading plan:
As a day trader, you will want to look at the open, close, high, low, and last closing price of a share before investing. This information is essential to make an informed trading decision.
There are various types of charts used by traders like line charts, bar charts, and candlestick charts. Of these, most traders prefer the candlestick charts as they offer detailed information in an easy-to-understand manner.
Each chart is drawn for a specific time frame. Hence, you have one-minute charts that track the performance of the share price every minute, hourly charts, etc. There are various free tools available online to help you get the hang of reading and analyzing them. You can also read our detailed blog on ‘How to read candlestick charts’ for more understanding.
If anything, history teaches us what to expect from the future. Even if it is not 100%, it gives you a good place to start. This is the basis of the concept of market correlation.
For example, what if I was to tell you that every time the NYSE (New York Stock Exchange) rallies, the BSE rallies too (at least more often than not).
If that’s what historical numbers tell us, then do we assume that the future markets will behave in a similar fashion? They may not. However, making trading decisions is all about probabilities and odds taken in a calculated manner. Hence, banking on prior market correlations can help you fairly estimate the direction of the markets and take a position accordingly. Also, if things go wrong, you have a risk management plan to prevent you from falling too far.
Every trader is unique and needs a customized trading plan. Here are some steps to follow to create the perfect trading plan for yourself: