Daytrading 101: What You Need to Know

Michael Sincere has helped thousands of beginning traders by way of his many books. In this interview, I ask him about getting started in daytrading today and what it takes to be successful and minimize risk to a new trading account.

We discuss the best indicators for beginners and how sentiment can be used to gauge whether the market is near a top or bottom. We also discuss the amount of money a new trader should start with and how to use stops to limit the downside risk in any one trade. I also ask Michael about the realities of trading for a living and whether it is possible to start daytrading while still holding down a full-time job.

If you’re a beginning trader and looking for some veteran guidance, this interview is for you. Markets discussed: Stocks, Options

Tim Bourquin: Hello everybody. This is Tim Bourquin. Thanks very much for joining me for another interview this week. Today, we’re going to be speaking with Michael Sincere. He is an author and a trader himself. He has written a bunch of books, Understanding StocksAll About Market IndicatorsAfter-Hours Trader that he co-authored and his latest book is Start Day Trading Now. So, I wanted to get Michael on the phone and talk to him about the state of trading and maybe talk about some of the books that he’s written in terms of indicators as well because I know those are always popular. So, Michael, thanks very much for joining me on the phone today.

Michael Sincere: Thank you very much, Tim.

Tim Bourquin: All right. Let’s talk about…I’m going to start right off with it. We’ll talk about your latest book, Start Day Trading Now, which as a title, I was a little surprised at because is now a good time to be a daytrader? I mean we all heard about daytrading before the dot com and it seemed like everybody was into it and then we lost a lot of people. Is it coming back? Is daytrading in vogue again?

Michael Sincere: I don’t know if it really ever completely left. There’s always a group of people who are always going to daytrade. I would say, the mass of people maybe have kind of moved away from it. But is it a good time to daytrade? I think there’s always an opportunity for daytrading, I mean for any kind of trading. In the book, I tend to talk about it as a strategy. So if you think of it as a strategy, yes, you can daytrade almost any time. So you can either use it as a part-time or a full-time strategy.

Tim Bourquin: All right. When you talk about daytrading as a strategy, obviously it means getting in and out the same day, but what kind of is the basis of a daytrader strategy that you’re looking at?

Michael Sincere: Well, first of all, it wouldn’t be scalping. That was where I think many people…or it got kind of a bad name. And scalping would be like you’re going in and out hundreds of times a day, for pennies. But the kind of strategy I’m thinking of is where you would focus on one or two stocks and definitely get in and out within the day for a point or two if you can, get what you can but before the end of the day. But most important is not to use the scalping strategies that gave it a bad name.

Tim Bourquin: So how are you recommending people go out and find these opportunities? What am I looking for in terms of price or indicators that you like to use?

Michael Sincere: Well, you’re looking for volatile stocks, I mean obviously, that are moving up and down. You try to avoid the penny stocks. I mean it really means monitoring, the stock market, looking for those opportunities and there’s many of them. I mean many stocks are very volatile. If you look at the top active stock, the ten top active stocks, they give you many ideas for what you can choose for daytrading.

Tim Bourquin: So that sounds like mostly stocks that have been in the news or announcing some sort of news that day.

Michael Sincere: Well, the news strategy is a little tricky. Yeah, that’s a tough one to implement. Some traders have done that very well, but often they do it the opposite. Once, the news is the released, they’ll go against the stock. But, everyone has their own idea of which stocks to pick. I mean some people have scanning software, which they set up a certain criteria and it will come up with a specific stock that they want to find. One thing, I tend to write for beginners. If I was a beginner, for a beginner, they would focus on let’s say one or two stocks and just master those stocks, become…learn the personality of that stock. And if you can get a somewhat volatile stock that fits that isn’t too expensive, and you can just follow it for a month or so, you’ll know. I mean you’ll get a much better feel when you can buy or sell it.

Tim Bourquin: So kind of just watching the ebb and flow it sounds like and when it’s headed down in pattern that you’re familiar with, that you’ve seen before, get ready to buy.

Michael Sincere: Exactly. Exactly.

Tim Bourquin: Okay.

Michael Sincere: I mean for a beginner, for a beginner. I mean obviously for experienced traders, they’re going to have their own list of stocks to watch or stalk as some say.

Tim Bourquin: One of the books, the “All About Market Indicators,” indicators of course are huge and especially newer traders are always looking for that Holy Grail indicator that will be 90% right and that they can just follow day in and day out. Then you’ve got this other crowd that says indicators are all rubbish. You should be following price only and looking at support and resistance and that’s all you need. What are your thoughts there?

Michael Sincere: Well first, there’s no Holy Grail. [Laughs] That’s what I’ve learned. They’re still looking for it, that Holy Grail indicator because if someone found it, you would never hear about it. They would keep it to themselves. So that’s the first thing I learned is that you’ll often read about people saying, “I found the indicator, the Holy Grail,” but again, they keep it to themselves. As for me, everyone has their favorites. From talking to many of the experts and the ones who actually created these indicators, my thoughts are first, on a technical side, you can’t go wrong or the one that seems to be most reliable in general, not 100%, is the moving averages. It’s simple, it’s easy to use and it gives you a very good guideline of which side of the market to be on. Another indicator for let’s say a larger picture, not for daytrading but for, say, investing or longer term trading would be the sentiment indicators. I found those really the most fascinating of all. And that basically is, you’ll look and see what the crowd is doing and if the crowd is really bullish, overly bullish, you do the opposite. So basically, you’re looking at how the sentiment is, if it’s bullish or bearish and then you really do the reverse of the crowd.

Tim Bourquin: Give us an example of a sentiment indicator.

Michael Sincere: Well, the two are the AAII I would call it. The American Association of Individual Investors, which is published, I think every week. And that one they’ll give the public. In my book, I actually give the web address and how to look those up and what rating. So basically, when it gets to a 60% rating of a bullishness that’s when you might want to do the opposite. Now it doesn’t mean on that day or that week. It’s just it’s kind of a trend that you’re looking at and as it gets higher and higher and if it gets to above the 60 level, it’s getting a little bit too much. I’ll give you an example. In March 2009, on the bearish side, it hit as high as 70% and as you may know that was the low of the market.

Tim Bourquin: Typically, the crowd is wrong. [Laughs]

Michael Sincere: Right, exactly.

Tim Bourquin: Now, do you follow then the Commitment of Traders Report? Is that the same kind of thing?

Michael Sincere: It’s the same kind of thing. I haven’t followed that as much. I know that a lot of people do follow that. I had mentioned it in the book, but I think it’s a similar thing for traders.

Tim Bourquin: Now, the moving averages, let’s just jump back to that for a minute. Do you have a favorite or one that you’ve found was the most accurate maybe for short term or let’s just talk about day trading since that’s our topic. Is it a 5-period, 20-period, what do you like to use?

Michael Sincere: Yeah. The 5 and the 10 are really good. First, I tend to look at an overall picture, which will be the 50, the 100, and the 200. And obviously the 200 even though it’s not technically for day trading, if the 200 is giving you a good reading, then as day trader, you can be on that side. I mean I would be bullish in a bullish market so but basically the 5 and the 10. The old moving crossover strategy is great. It tends to work and again not 100%.

Tim Bourquin: So kind of waiting for a short term to cross above the longer term average as a buy signal?

Michael Sincere: Exactly. And then below on that sell signal.

Tim Bourquin: Do you also use moving averages to place stops? Is that a method?

Michael Sincere: Yeah. And again, I interviewed some of the best traders so I would have to go with… I mean their expertise is tremendous and a lot of them do use it as stops. Do you know what I mean? Me, personally, I tended to have my own method for stops, but it’s not moving averages. I mean what you really have to do, as I give anyone advice, is really to experiment to find out what works for you. I mean everyone has their own method. that’s probably the best advice I can give is just to experiment and find your own method.

Tim Bourquin: In your new book, you also talk about managing risk and how important that is for a day trader. How does a day trader manage their risk?

Michael Sincere: Man, first, I can tell you that I have a PhD in all the mistakes that you can make. So that’s one thing I can tell you right there. So I know a lot about managing risks. Managing risks, first it does come back to the stops. I mean before you enter any position, you always want to know what’s the worst that can happen. You want to really know an enter price and exit price. So before you get in to manage risks, know where you’re going to get out. So many people just don’t put stops and it’s unbelievable to me. So as a day trader, you’re going to keep tighter stops because, things are moving much more rapidly. So that’s probably the first step of managing risks is using stops, either trailing or regular hard stops.

Tim Bourquin: How about the position size itself, does that figure into the equation?

Michael Sincere: Yes, it does. It does. one of the mistakes a lot of people do is they will just always do a thousand shares all the time without…It doesn’t matter the risk. It doesn’t matter the size. But you really want to vary that. I mean it’s part of an equation. Some of the risk-reward equations that I talk about in the book they can get really complicated and really the idea is to keep it as pretty simple as you possibly can, the calculations. But as far — as a beginner, I’d basically advice starting with a smaller amount of shares and then as you get more experience, you can increase those shares. But the main thing is don’t just say 1000 shares all the time.

Tim Bourquin: The question that always comes up in terms of and its related to share size I guess is how much money do I need to start to day trade? Should I take $20,000 out of my retirement account to do this? Do I need $10,000? Can I start with $250 on some on these Forex firms that offer that? What’s your advice there?

Michael Sincere: Well, first if you’re a beginner, if you’re a novice trader…I mean first, there are rules on what it is to be a day trader. And first thing before I forget is do not take your money out of your retirement. That should be separate, okay. Daytrading is a…what I often say is that you should have one account for let’s say long term investing, which could be your 41k and then another account for let’s say trading. Now as far as the rules of trading, you need a minimum of $25,000 if you are going to be a pattern day trader, which means you’re making four trades within a five-day period. So if you are going to make four day trades within a five-day period, you will have to have that minimum $25,000. Also, you could be a part-time trader and you won’t need to do that minimum. But being a part-time trader, it’s always tricky to limit yourself to less than those four trades. so as far as…Again, when I’m talking to novice traders, I say start small with small share size and a few thousand dollars. I hate to even put a number on it. But just I would I say a smaller share size. But no, don’t put $20,000 into the market at one time if you’re a beginner because I can almost guarantee you’re going to lose it.

Tim Bourquin: And it’s about being comfortable I guess with that risk. If you’re constantly, biting your fingernails about losing this money, you’re going to make probably bad trading decisions.

Michael Sincere: Yeah. I mean the real trick to the whole thing is an education. I mean that’s why you go to shows, you go read books. You really need to educate yourself. The mistake people have made in the past is they read one book or something or they talk to a group of people and they think, okay, I can day trade. This is easy. Well, learning how to day trade is easy. the mechanics of it is not that difficult. The hard part is the psychological part, not fully understanding the risk of what’s involved. And that’s why so many people got killed. I mean they thought, oh, it’s so easy to make a point in a day. Yes, it is, but it’s just as easy to lose that point and people weren’t ready psychologically for that. And that’s why like any educational thing, like any endeavor that you do, it’s really important that you take the time to learn it. We’re not talking about a couple of days or weeks but months to learn and to practice.

Tim Bourquin: Now for a lot of people back in the late ’90 or early 2000s, it was all about quitting the job to trade full time. That seems to have gone away quite a bit for most people. If somebody is going to start day trading, how do they do that though if they’ve got a full-time job? They’re going to be at work during most of market hours. Any advice there?

Michael Sincere: Yeah. I mean you can set up stops. I mean obviously first you start educating yourself. Some people I’ve known actually will put in their order before they got to work but put in a stop. like a buy stop so if it reaches a certain point, you will actually buy and you can actually set it up that after a certain point, it will sell. So you could set up automatic buys and sells. some would argue that that’s really not recommended, I mean, because you’re really leaving a lot to the computer. A true dedicated day trader will not leave their computer. They will be sitting there and watching it. But if you are doing it on a part-time, occasional basis, and you’re not risking a lot of money, and you’re at work, you could try this out and see if it works. If it doesn’t work for you, don’t do it. To add to that, I would say it’s not recommended, but there are ways to get around them I mean.

Tim Bourquin: And I suppose you could check your portfolio at work occasionally and not get in too much trouble.

Michael Sincere: Exactly. Exactly. Basically, with the phones and everything, I mean you can really do monitor outside of work. But the main point of that is to set up stops. So if you are going to set up a trade early then be sure you have a stop on both sides of it.

Tim Bourquin: There’s so many things to trade these days. Every day, the exchanges come out or companies come out with new products to trade, new ETFs, new futures, contracts, where does somebody start? We’ve talked about stocks here, but could I start with futures? Should I start with options?

Michael Sincere: Well, I can give you my own opinion from just talking to other people. They say that with futures, it’s very, very difficult to do well in the futures market. I mean it’s that — and I even have some stories from friends who’ve tried it. So I would say it takes a very, very special kind of dedicated person to master the futures market. For a novice person, they’re going to get killed, in my opinion, in this if they started fooling around with futures. That may change in the future, no pun intended. They may come up with other products. But right now, as it stands… Now options, as you may know I wrote a book on options. So there are option strategies that are actually less risky than stocks and one of them are like selling covered calls. there are some risks, but as long as you’re aware of them, they can be managed. So I would say stocks are within the realm, options are within the realm. But again, I’m not an expert on futures so someone might disagree on that. But for a novice, I would say avoid the futures market.

Tim Bourquin: So for someone just getting started, start with some stocks that are volatile, low share size, put some moving averages up there and are there other indicators? We hear a lot about Fibonacci, things like that that I should be looking at?

Michael Sincere: I talked about Fibonacci. Fibonacci is out there. Some really love it. They think it’s the greatest thing in the world. Others are like this is beyond — this is a magical mystical thing. There are enough people who believe in Fibonacci so there is something to it. But I wouldn’t start with that. That would be probably one of the last indicators. the ones that are the top five would be the moving averages, the MACD, the Bollinger bands, stochastics are really good or RSI, they tell the same thing. So those five are a great place to start as far as indicators and you can get most of the information you need from those five. But Fibonacci is pretty much out there. I mean, it would take a lot of study to really master that one.

Tim Bourquin: All right. Let’s finish up just talking about the current market conditions as they stand here. Gold hitting all-time high, silver hitting all-time highs, oil seems to be rising a little bit here. The stock market continues to go up even though people are talking about inflation and quantitative easing that sort of thing. Any general thoughts here about the overall market and where we’re headed?

Michael Sincere: Well, I can say one thing is that people still don’t believe in the stock market and that from a sentiment’s side, that’s really positive for the stock market. There are people who just can’t stand the market and they are just waiting for it drop and meanwhile the market, as it often does, fools everybody and keeps going up. if you look at the indicators there, I mean there have been a couple of setbacks. But in general, the market has been above the 100, it’s been above the 200. It was — I haven’t looked at it in just the last day or two, but it got right on the edge of it I think on the 50 actually and then now it’s above it. So my feeling is that it’s positive. I mean everything is looking positive. Obviously, there could be unexpected events that could take it down, but at this point, you have to go with the trend. One thing I’ve learned about indicators and about the market is that no one can really with any degree of tremendous accuracy predict what the market is going to do. But what you can do is gather all these clues together and that includes indicators and make a diagnosis. Now, if I was going to diagnose it now, I would say it’s very positive and obviously that could change very quickly. So that’s my thought right now. Now as far as gold, it’s been ten-year bull market and I guess we’re going on 11 years. So what I do is I’ll look for clues that there could be a reversal and even though there’s a lot of negative news out there, I mean someone could easily make the negative side of this. You want to see how is it going to affect the stock market and until I see those clues that are going to negatively affect the stock market, I would still be long.

Tim Bourquin: What does that look like, those negative clues? What would you be looking for?

Michael Sincere: Well, obviously, inflation going higher. I mean we have what’s happening in Japan. We have the Middle East. All of these things could affect it negatively. I mean there might be a government shutdown they say in a few days. That would be unbelievable for the stock market. I mean that’s something you really have to watch for. I mean as a trader, you’re always looking for those kinds of signs. But if the government shuts down, that would not be good.

Tim Bourquin: A lot of fundamental things to be aware of right now.

Michael Sincere: Yeah. It’s one thing about trading is that you tend to — you need to look at some of the fundamental factors as well as the technical factors, at least that’s what I find a lot of traders will do. Some only are technical, but I find that a lot of traders will do both. And same with investors, investors will often, not just look at fundamentals but look at things like moving averages and the MACD and the MACD by the way is a favorite for a lot of investors all that —

Tim Bourquin: Yeah. I know a lot of them put it up on their chart for sure.

Michael Sincere: Yes.

Tim Bourquin: Well, Michael, what’s the best way to take a look at your books? Go to Amazon? Do you have a website? Where should we send some folks?

Michael Sincere: Yeah. My website is www.michaelsincere.com.

Tim Bourquin: Easy enough.

Michael Sincere: All my books are on there.

Tim Bourquin: All right, great. We’ll link to that.

Michael Sincere: Or go to Amazon, Barnes & Noble and almost every bookstore in the world I guess.

Tim Bourquin: All right, great. We will link to that and send folks over there to take a look at some of the books you have and your latest one of course. So, Michael, thanks very much for your time on the phone today.

Michael Sincere: Great. Thanks.

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My Favorite Trading Books

I’m often asked to name the best books for rookie traders. In my opinion, there are a few books that stand out from the rest, which I listed below. A few years ago, I wrote an article for Fidelity Investments, “Ten Essential Books,” which listed my favorite books for investors and traders at that time.

Many of the same books are still just as useful. Here is a link to the original article:

http://bit.ly/gTIZi1

And now, here is an updated list of my favorite trading books (in any order):

How to Make Money in Stocks by William J. O’Neil

How I Made $2,000,000 in the Stock Market by Nicolas Darvas

A Beginner’s Guide to Short-term Trading by Toni Turner

A Beginner’s Guide to Day Trading Online by Toni Turner

Reminiscences of a Stock Operator by Edwin Lefevre

Trading for a Living by Alexander Elder

Come into My Trading Room by Alexander Elder

Japanese Candlestick Charting Techniques by Steve Nison

Market Wizards and The New Market Wizards by Jack Schwager

Stock Traders Almanac by Jeffrey and Yale Hirsch

The Disciplined Trader by Mark Douglas

Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay

Trade Your Way to Financial Freedom by Van K. Tharp

 

Trading Options

If you are trading options, check out the book, The Rookies Guide to Options by Mark Wolfinger, who is one of my friends. When I have an options question, he’s the guy I ask. Another options book that I like is Options for the Beginner and Beyond by W. Olmstead.

If you have your own favorite books, please email me the names and I will include them in a future article.

What Daytraders Can Teach Investors

MIAMI, Fla. (MarketWatch) — With the huge advances in the stock market over the past year and heightened volatility, daytraders are back. Or maybe they never left.

In the 1990’s, daytrading was all the rage, especially using risky strategies like scalping, where you’re in and out of hundreds of stocks in seconds or minutes, aiming to make small but quick profits.

More recently, scalping is the strategy of choice of high-frequency traders (HFTs), the ultimate daytraders, who use high-speed computers to scalp for pennies in nanoseconds. Those pennies can add up to billions of dollars in trading profits every year.

Although retail traders can’t compete with these advanced computers, many lone daytraders have returned to the stock market using a variety of sophisticated trading strategies.

Margin and the “Pattern Daytrader”

One reason that daytraders previously got into financial trouble was because of margin. Margin, the borrowing of funds from your brokerage, is a useful tool if used properly, but dangerous when misused.

At most brokerages, you can borrow up to 50% of a stock’s value. For example, if you have $10,000 in stock, the brokerage may lend you an additional $10,000 to buy more shares (that’s 2:1 buying power). The Federal Reserve, not your broker, sets the maximum you are allowed to borrow.

You get much more buying power if you are deemed a “pattern daytrader,” which is anyone who makes more than four daytrades within a five-day period. The downside: Once designated as a pattern daytrader, you must keep a minimum of $25,000 in your account at all times.

If you are a pattern daytrader, you will probably be allowed 4:1 intraday buying power, or leverage.

For example, if you have $30,000 in your account, you will be given enough buying power to buy a total of $120,000 in securities. This is total for the day because overnight, the margin rate returns to 2:1.

To get around these restrictions, some daytraders only trade part time, although it’s then not easy to stay within the rule of making four daytrades within five days.

While most people don’t have the discipline, time, and guts to daytrade full time, trading part time can make sense for many people. If used in this way, daytrading is just another strategy applied during certain market conditions.

Strict Rules

Although many people tease daytraders for having short-term outlooks, they can teach you a thing or two.

To survive, they follow a strict set of rules. For example, rule one is never carry a losing stock overnight (although some daytraders will hold a winning stock for a second day).

Selling a loser is hard for many people, who often hope their stock will come back to even. One way to cut losses or to lock in gains is to use stop losses, especially trailing stops. Trailing stops, which can be entered as a percentage or a dollar amount, adjust or trail behind a rising stock price.

Example: You buy a stock at $25 and enter a trailing stop order of $1. Every penny that the stock moves higher, the trailing stop increases by one penny. If the stock moves to $27, for example, the trailing stop order tags along, adjusting higher. In this case, if the share price then falls to $26 (-$1), an order is triggered, and becomes a market (or limit) order to sell. You can also set a percentage of 1% or 2%, for example.

Unfortunately, while trailing stops are effective when a stock makes a substantial run, trailing stops may not trigger under extremely volatile conditions. Therefore, if you’re aiming for smaller profits, you may want to use hard or mental stops. In addition to a trailing stop order, you should also experiment with trailing-stop limit orders.

No matter what you think of daytrading, it’s clear that many people have learned from the past, when unknowledgeable traders quit their jobs and cleared out their 401(k)s to daytrade. Many modern daytraders trade less frequently and are choosier about the buys and sells they make.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), Understanding Options (McGraw-Hill, 2006), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).