Day Trading Strategies

            Sooner or later every successful day trader learns in great details the topics covered in this paper, and the greatest asset they have is experience. In reality, day trading is driven by psychological and emotional stimulation through constant speed, action, and risk. In modern times, a diverse, global basket of speculative mediums and faster than lightening electronic trading boards feed the day trader’s market adventure addiction. The day trading population is dense and saturated with “get rich quick” philosophies and day trading strategies that produce both wealth and bankruptcy. Richard Wyckoff one of the greatest traders and educators ever lived once said “a mediocre trader will trade based upon tips; gulp down a point or two; and downplay the loss, unless the loss is massive enough to strangle him”. Nonetheless, a significant percentage of day traders have been successful in day trading the markets using a combination of modern technology driven data analysis, knowledge, skill, and day trading strategies. This paper will provide an overview of day trading; followed fundamental principles and strategies used by successful day traders to analyze and draw profit from the markets. The aim of this paper is to cut the learning curve for those new to the market, or simply those not seeing great results yet.

1.1 Overview

            Toward the close of the 19th century, fast, furious “trading” of securities in “bucket shops” marked the primal stage of day trading; which evolved to greater heights of sophistication with the invention of the telegraph; and subsequently, the ticker tape. After the stock market crash in 1929, more modern day exchanges were “re-created”; and by 1971, the National Association of Securities Dealers Automated Quotation (NASDAQ) system was in place.  However, it was the development of the Small Order Execution System (SOES) and the NASDAQ Electronic Communication Network (ECN) that opened the automated market gates to day traders\. The “SOES Bandits” made quick hits, liquidating the market and creating permanency for the individual, short term traders.

1.1.1 Day Trading basics

            The buying and selling of a stock in the same day constitutes a day trade. The fundamental components of day trading consist of reading the time and sales window; creating stop losses and stop maximums; and the use of time proven day trading strategies. Individuals who seek term profit through continuously trading at a daily rate are referred to as day traders, or intraday traders. The day trader is typically mentally active; flexible; capable of rapid, accurate decision making; and minutely sensitive to the smallest, most imperceptible indications and signals (Wyckoff, 1919). (Eng, 1993) presented that futures, equities, and options day traders “are a special breed of investors that are actionable; exceptionally knowledgeable; and aggressive”.

            Day trades are accompanied by commission fees; taxes; exchange fees; the ‘invisible eighth’ add-in; and interest for assets held over night. The startup capital requirements for day trading vary dependent upon the type of day trading, exchange, or the type of market. Some markets, such as Forex, require as little as $500 in an account; while trading options and futures may require from $1,000 to $10,000 in an account; and stocks may require approximately $25,000 in holding. Wyckoff contributed that:

“the day trader gauges the energy or impetus of the stock chart movements and sustenance of the movements in order to measure the probability of the movement traveling far enough to warrant pursuit; whether it will compensate for expenses and renumerate for boldness”.

Thus, the day trader avoids markets that swing in accordance to a few points, as with the exception of the extremes, the trader cannot pay commission and fees; take losses and still produce significant profit.

1.1.1. Reading the Times and Sales Window

            The first morning hours of the day reflect high volatility in the markets; the development of new trend lines on the tape; and other market details for the day trader. Therefore, the day trader must be skilled at reading the tape as well as reading stock charts. Reading the tape, or the time and sales window, is a method of obtaining data and transactions histories for an asset, to include price action; order size or volume; time of trade; and the conditions of the order. Day traders use the tape to “follow the money” using price patterns; speeds; breakouts; and levels of support and resistance as indicators. Wyckoff presented that “the big profits in reading the tape are made in highly active markets as big swings and large volume combine to produce irrefutable indications and earnings for the experienced trader, who welcomes 20, 30, and 50 point moves”.

            The time and sales window displays the order sizes from the market makers book. Desirable long trades feature high bid size and low ask size; while the desirable short trades feature low bid size and high ask price on the tape. Figure 1 shows a time and sales window with real time quotes, account management tools, and rapid execution times:

Figure 1. Time and Sale Window

The window show detailed data in regard to the order flow for a specified security. The order condition indicates which side of the bid-ask spread the trade was initiated. The size of the order reflects price action; while the order speed reveals the interest in the security. When breakouts occur through the resistance or support levels, the order size and the speed increase. The time and sales window in fig. 1 may be linked to the trader’s options quotes.

2. Setting Maximum and Minimum Stop Losses

            The stop is the day trader’s tool for closing trades that are not performing to expectation. However, methods of determining when to close the trade must first be addressed by the trader; and subsequently expressed through setting maximum and minimum stop losses within the trading account.  Wyckoff presented that, in regard to whether or not “the trader should close all trades at the end of each day or hold the stock through reactions”, the best approach is “based upon the temperament of the trader, whether the trader can follow small swings with profit closely; or the trader is more content with waiting for the next big opportunity”. In this light, the day trader may sets stops to indicate the maximum loss the trader is willing to accept for a position.

            The stop loss specifies the limits for stock price fluctuations. A stop loss set to 10% indicates that price fluctuations that fall beneath the entry level price by 10% should close the trade. The maximum loss specifies the maximum loss that is acceptable as a result of the trade. The maximum loss  limits are impacted by whether the account is for investing or day trading; risk profiles; diversification levels; time frames; and the trading margins.

            The stop is the point of invalidation, in which the original reason for trading the stop no longer exists, or is no longer valid. The use of the stop reduces the trader’s anxiety from holding a losing trade with no plan. The stop also reduces periods in which the stock is exposed to risk; as increases or broadening of stop limits are equal to increases in risk. The stop out level is a predetermined point of exit for losing trades that may be expressed through different forms of limitation. Forex traders use limit orders to close out losing trades automatically based upon predetermined points of exit.

2.1 Stops Based Upon Percentage

            The intraday trader has the option to establish limits to the percentage of the trading account may be used in the trades based upon the percentage risk. Traders with lower aversions to risk typically set the stop at lower percentages than more aggressive traders.

Factors that impact the percentage level include market conditions; risk management standards; and the financial outlook of the trader. Wyckoff concluded that a significant percentage of losing trades are inevitable irrespective of the length of the strategies used by the trader.

2.2 Stops Based Upon Price Volatility

            The current price and volume of an asset are the primary concerns for the day trader, as the price dictates the current market value and the volume dictates the degree to which large investors are interested in the asset. The price volatility provides information in regard to how much the asset price behavior tends to fluctuate that can be used to set stop loss limits that reduce the instance of prematurely being removed from a trade based upon random price fluctuations. Bolinger Bands may be used to measure the price volatility. In range trading, the stop limit is set beyond the level of the bands. The Average True Range (ATR) may also be used as an effective indicator of price movements. Some day traders prefer to trade the most volatile of stocks, as the volatility is interpreted as a heightened public interest in the asset and strong volume.

2.3 Stops Based Upon Support and Resistance from Charts

            The price movements of an asset periodically are challenged in movement beyond a certain level.  Support and resistance are representations of supply and demand as support represents the price level for strong demand and resistance represents the price level for strong selling action. Traders may manually search for support and resistance from hourly, daily, and weekly charts, or by use of software tools. Wyckoff (1919) supported that closer stops may be obtained by notations of the stock’s points of resistance, or the level upon which the market turns after a reaction. Stop losses that are too low may cause the trader to be stopped out of trades. Therefore, the stops are generally set beyond the support and resistance levels. The trader may  buy dips and sell rallies by trading in the optimal direction using measures of support and resistance for the day.

2.4 Stops Based Upon Time Limits

Time is of the essence in day trading, with the most crucial period for most being the first 5 minutes of market opening. Price, volume and gaps from the previous day may be observed, as well as real time market volatility. Wyckoff presented that “traders are overly proned to remember the profits and to forget their losses”. Further, due to associated fees, it is undesirable for the intraday trader to hold stocks over night. 

            Placing a stop according to time eliminates trades that have not performed as expected within a specified time period (Babypips, 2016). The time period may be for hours, days, weeks, weekends, months, during specified seasons or trading sessions. The significance of timing extends to determination of the readiness of the market to be traded, as days prior to and after holidays; impactful news releases; and other factors directly influence the trading strategy.  While stop losses that are too low may cause the day trader to be stopped out of trades; stop losses that are set too wide may cause considerable losses due to unanticipated, dramatic changes in the asset price.

3. Day Trading Strategies

            The diversity of the exchanges and the types of assets is also reflected in the number of strategies that day traders employ in order to minimize risk and maximize profit. The professional trader operates based upon “well defined rules or codes, strategies, or methods, as opposed to intuitive readings of the tape (Wyckoff, 1919). United States President Elect, Donald Trump wrote The Art of the Deal, in which he stated “in environments of so great a demand, the optimal strategy is to play hard to get. The more unattainable the asset appears to be; the more people want it” (Trump, 1987, p. 184). However, the complexities of day trading, compounded by the potential impact of unforeseen events, require in-depth analytical strategies that extract insight from available data and market analysis tools.

            The choice of trading strategy dictates when the trader should enter and exit the market. Modern day trading strategies typically  incorporate the use of charts to analyze stock data. (Eng, 1993) proposed that the 5 minute bar chart is the most simplified strategy for daily, weekly, and monthly analyses of market data; and that only experienced day traders with knowledge of the Elliot Wave should use tick-by-tick charts. Wyckoff also supported that the trader must close a trade “when the tape dictates to close the trade; when the stop is caught; when the position is ambiguous; and when profits are sufficient”.

3.1 Using Level 2 Quotes

            The level 2 is the NASDAQ order book that provides insight into the price action of the security, to include trader profiles and near term trends. Real time level 2 quotes build visibility and cover all broker/dealer quote prices in real time, which are indicators of the liquidity that is available in the securities. The level 2 lists provide the best bid prices and ask prices from the market participants. Figure 2 shows level 2 quotes for SPY:

Figure 2.  Level 2 Quote Window

The data includes options liquidity at all price levels; real time quotes feeds; potential resistance and support; and also scalping options. The trader can distinguish between retail and institutional transactions; irregularities in ECN order size; trading with the ax; and trades between bid and ask. On the contrary, the level 2 quotes may be deceptive, as market makers hide the true sizes of their orders and throw off the trade through displacements of time.

3.2 Pivot Levels

            The pivot point describes the average low, high and close asset prices for each day. Pivot points may be used in day trading strategies that encompass buying when the market reaches a pivot level and selling when the market reaches a resistance point (Marwood, 2014). The pivot point is to be used to buy only when the market displays an upward trend; and only to sell when the market displays a downward trend. Thus, the day trader may use pivot points to establish the upper and lower limit stops. The pivot may also be used as profit targets and trend indicators.

3.3 Chaikin Money Flow Indicator

            The Chaikin Money Flow indicator may be used to measure the Money Flow Volume for a specified period of time. The Chaikin Volatility indicator reconciles price movements and increasing volume. Day traders use the indicator to measure buying and selling pressure for assets during a single period, as the buying and selling pressure supports determinations of future changes in the market.  The Money Flow value varies between 1 and -1: higher buying pressure drives the indicator to 1 and higher selling pressure drives the indicator to -1. Within the bullish trend, the continuous buying  pressure indicates an increase in the asset prices; while in the bearish trend, continuous selling pressure indicates prices will continue to decrease. A cross over the Zero line is an indication of a potential reversal in the trend.

3.4 Momentum

            Day trading strategies are often based upon momentum, in which the asset price displays unique, significant movement. The stock is typically small with limited numbers of outstanding shares and the stock price movement may fluctuate by as much as 30% or 40%. However, locating sufficient momentum can be the most challenging aspect of the strategy. Daily charts are often used to view the past trading histories of the chosen market, to include assets with gaps, extended range bars,or near 90 day breakouts.  When the price rises, the trader examines the movement and established stop losses below the initial price decline. When the asset price breaks out above 90 day high, the trader waits for a confirmation signal prior to entering the market.

3.5 Trends 

          Trading strategies based upon trends may analyze the market data in regard to accumulation breakouts; distribution breakdowns; pull back; reversals; or continuations. A basic principle to remember is to trade long when markets are strong; and to trade short in weakness, never the opposite.

            Pull back trends represent retracement that is short term, which can create a buying environment. A common pattern is created during a pull back called a flag. It can be a bull flag (continuation pattern to the upside), or a bear flag (continuation pattern to the down side). The pull back strategy (or a flag pattern) is initiated by searching for assets with an established trend, and to monitor it. When a price decline occurs and the trend that is established is upward in direction; a pull back may be confirmed for entry to buy.

            Increasing and decreasing pricing trends are often identified through analyses of exchange premiums in charts. Distribution trends are characterized by large volume sales, as the trader perceives that the stock price has reached its maximum. Reversals are distinct changes in trends which dictate either buying or selling based upon the direction of the original trend.

3.5.1 . Trading in Harmony with the Longer Term Trend

            A common and very important day trading principle is to always trade in harmony with the trend that is one time frame above the current trading frame. The objective is to align the trades with the overall direction of an active market. Doing so increases the probability of success greatly.

3.6 Basket Trading

            Basket trading encompasses simultaneously buying or selling of approximately 15 or more securities in order to protect the portfolio allocation (Wilson, 2013). For day traders, the basket trade can be used to sent multiple orders for a diversity of securities based upon the same set of user preferences. Figure 3 shows an interface for List Order Entry:

Figure 3. Basket Trading List Order Entry Window

The order type, price, side, target, frequency and size for the securities are displayed for the listed market and the Over-the-Counter (OTC) market. The trader may use the Exchange Traded Funds (EFT) basket trading interface to create personalized, weighted indices.

3.7 Pump and Dump

            The pump and dump, also called ramping, is a fraudulent day trading strategy using promising statements in regard to penny stocks to inflate the price. The power of traveling news is the primary weapon. The trader selects a penny stick with no institutional followers and low liquidity from industries  with strong storylines, such as gold mining, biotechs, and bitcoin. The trader purchases a percentage of the free float and attracts mug punters advertising a high return for the stock based upon recent events. The price is driven up by prospectors; at which time the day trader takes profits. It's considered a highly unethical strategy and one that not needs to be used in order to gain wealth from the market.

4. High Unusual Volumes

            Volume along with price, has been used as a confirming trading indicator from the onset of the exchanges. High volumes of shares during the trading day indicate heightened interest and price action, and with high interest comes high conviction through momentum. Wyckoff presented that “certain market prices are likened to two scales, the market volume of stock that has been thrown out by the sellers and grappled for by the buyers; which reflects which side the predominance of weight has shifted for the movement”. The trader may use volume as a guide as to whether the enter the market on the aggressive or conservative side with new positions.

            Volume is commonly used in breakouts and false breakouts; trends; and volume spike analysis as representations of the market direction. Typically, trends  in which the price increases are expected to be accommodated by concurrent movements in volume. The volume progresses toward the trend  throughout the day, with fluctuations during certain time frames. Volume spikes occur after news events that drive the volume movement significantly in short periods of time.

5. Conclusion

            Each day the stock exchanges are bombarded electronically with individuals that speculate with regard to the market behavior. The primary motives for day trading may range from independence, security, and financial freedom to psychological adrenaline and greed. It may be concluded that traders that are driven to day trade possess unique preferences in regard to types of investment and time frames. Wyckoff presented that “the authentic day trader will prefer a clean slate at the end of each market day as to be available for the next morning opening at the ticker with no commitments or opinion”. A diversity of trading strategies are applied at the start of the day, following the critical first 5 minutes of market open. Lastly, the best way to be a successful day trader is to stick to a proven strategy, being patient, and gaining experience; trading only the best high quality setups and leaving the rest.


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