INTRODUCTION TO SHORT-TERM TRADING
Short-term trading is lucrative yet risky. It lasts from a few minutes to several days. Traders must be able to understand the risks and rewards encompassing this trading strategy. Not only they should know how to determine short-term opportunities, but also protect themselves against unforeseen events.
How can a trader profit from short-term trading without risking too much?
To achieve success in short-term trading, there are several basic concepts a trader must learn and master. One is identifying potential candidates. A good trader can differentiate a good potential situation and bad ones. Many investors are too updated with evening news and financial pages, believing doing such will put them on top of the game. However, by the time we hear the news, the markets are already reacting. There are some steps to follow to find the right trades at right times.
Monitor moving averages. Moving average refers to the average stock price over a given time period. The most common time frames are 15, 20, 30, 50, 100, and 200 days. It aims to show whether a stock moves upward or downward. A good candidate in general will have an increasing moving average that is sloping upward. If looking for a good short, you may want to look for an area where the moving average is smoothing out or declining.
Understand Overall Cycles or Patterns. Markets trade in cycles, so it is important to track the calendar at given times. Since 1950, most of the gains in stock markets have occurred during the November to April period, while averages have been relatively static during the May to October period. Traders can use the cycle to their advantage to identify good times to go long or short.
Perceive Market Trends. In the event of a negative trend, a trader may want to go short and do very little buying. If positive, he may want to buy and do very little shorting. Take note of this: When the overall market trend goes against you, the odds of having a successful trade decline further.
Another concept to learn is controlling risk. Short-term trading entails minimizing risk and maximizing returns. To protect oneself from market reversals, he must use sell stops or buy stops. Both are designed to limit the downside. Let us define the two. Sell stop is an order to sell a stock once it reaches a preset price. Upon touching the price, it becomes an order to sell at the market price. Buy stop is used in a short when the stock escalates to a specific price and becomes a buy order. You must remember that in short trading, set the sell stop or buy stop within 10% to 15% of where you bought the stock or began the short in order to reduce losses.
Now meet technical analysis. There’s an old maxim in Wall Street: Never fight the tape. Most markets, whether we admit it or not, always look forward and price based on what is happening. Meaning everything about earnings, management, and other elements are already considered in stock pricing. Now going back, technical analysis refers to the process of assessing and studying the markets or stock by looking at past prices and patterns in order to forecast future movement. Below are some of the tools and techniques used in technical analysis:
- Buy and Sell Indicators – In essence, there are various indicators employes to find the right time to buy and sell. Here are two of the most known indicators:
- Relative Strength Index (RSI) – This indicator compares the inside strength or weakness of a stock. A reading of 70 denotes a topping pattern; a reading below 30 implies an oversold stock.
- Stochastic Oscillator – It determines whether a stock is costly or cheap according to the stock’s closing price range over a given time period. A reading of 80 indicates an overbought stock; a reading of 20 signifies an oversold stock.
- Patterns – Patterns refer to change in direction (up or down) in the stock’s price, as well as changing expectations. These are commonly developed over numerous days, months, or years. The following are the important patterns to follow:
- Head and Shoulders – Considered one of the most reliable patterns, it is a reversal pattern when a stock tops out.
- Triangles – Prices bottom or top out. As the price constricts, it demonstrates the stock can break out to the upside or downside in a violent manner.
- Double Tops – Prices climb to a particular point on heavy volume and then retreat. Then a decline happens and the stock lowers.
- Double Bottom – Prices drop to a specific point on heavy volume. Then it rises and goes back to the initial level on lower volume. Since it cannot break the low point, prices ascends again.
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