In this first week of our five–week course on day trading, we want to define what the business of day trading is and what it is not. We will discuss the differences between professional direct-access day traders, and those traders attempting to accomplish the same thing through on-line brokerage firms with internet ISP hook ups. The SEC has expressed many concerns regarding the explosive growth of on-line day trading, and we will address their concerns in this first installment of the course. We will explain why day trading is potentially a valid and rewarding business, but at the same time, we will make you acutely aware of the various hurdles you must overcome to succeed. Successful day traders must maintain a proper psychology, mental attitude, and focus. In addition, you must work with superior technology, have sound money management strategies, and develop a thorough knowledge of the markets. Of most importance, you must understand the risks involved in trading stocks. I realize that this information may be dry, but it is essential that you have this base of understanding before proceeding.

The professional day trader is a person who trades stocks in the office of a registered broker dealer. With the right amount of training, experience and communications, some of these traders will eventually trade remote from their homes. Registered broker dealer firms provide the direct access communications (T–1 lines) and electronic execution equipment/software that puts these traders the same execution access level as the Merrill Lynch’s and Goldman Sachs’s of the world. The software used for execution and monitoring the markets is often far more advanced than what I’ve seen or used on major brokerage firms trading desks. Day traders that work in this situation can compete on an execution basis with the NASD market makers and other electronic systems or ECN’s.

Day trading by definition means that you end each day flat, meaning you go home without any open positions at the end of the trading session. Day trading is not taking home 500 shares of NEON at 44 on July 6, 1999 (see number 1 on chart) and watching it open on July 7, 1999 at 18 3/8 (see number 2 on chart). As you may recall, New Era of Networks, Inc. (NEON) announced a large earnings shortfall after the close on July 6, 1999. I use NEON as an example of the problems you can face by not ending each day flat. In the case of NEON, you would have lost most of, if not all of your equity and would have received a margin call that you would be unable to have met. No, this doesn’t happen often but it only has to occur one time to possibly put you out of business. The media then runs a story about the perils of day trading which they, in reality, confuse with on-line brokerage trading where the person just gambled and took a shot.

That kind of trade is not what the day-to-day business of trading is about. Investors buying securities on margin may not fully understand the risks involved. In volatile markets, investors who have put up an initial margin payment for a stock may find themselves being required to provide additional cash (maintenance margin) if the price of the stock subsequently falls. This is where many newer day traders run into problems. If the funds are not paid in a timely manner the brokerage firm has the right to sell a securities position and charge any loss the investor. When you buy stock on margin you are borrowing money. As the stock price changes you may be required to increase the cash investment. You should make sure that you do not over-extend.

Translation: Don’t buy it on margin if you don’t have the allocated cash reserve to pay for it in cash. As mentioned earlier, a simple margin example of a trade that recently occurred was New Era of Networks, Inc. (symbol NEON). The NEON example will highlight margin risk. If you are to succeed at the day trading business, you have to run it like one. At the end of the trading day you take no position home overnight. By adhering to this discipline you avoid the overnight risks that traders A&B both had with NEON. Day trading is limited by time and the average range of the stock, but you will be in better position to control your risk and the size of your losses. This is the key part of the "traders equation".

The average size of a day trader’s profit will be smaller than that of a short-term position trader because of time and range. Day traders will be stopped out much quicker than position traders due to daily market noise such as programs and announcements from brokerage firms and the companies themselves. The most important thing you must manage as a day trader is the size of your loss. Secondly you must manage a winning trade to maximize the profit on each trade. Your motto will become "make a point – lose a quarter". And you want to do this as many times as you can.

Day traders in an effort to keep losses small will get stopped out often and this makes it hard to maintain a high percentage of profitable trades. Our trading plan is to select the most promising opportunities; that is the stocks which are most likely to move in the direction of the trend with maximum range. In order to accomplish this you will select from the strongest of the institutional stocks that have pulled back from their swing point highs or are coming out of consolidation in the direction of the trend (sells reversed). You will be even more profitable if you learn to recognize the dynamics of supply and demand and not just some shape of a pattern or a formation. Buyers and sellers are constantly making decisions and we, as traders want to be on the same team that is currently winning the war. We will cover these dynamics later in the course.