If you are just starting with day trading, it may seem like there is a whole mountain to climb. And you may be right. Day trading can be really challenging for those who aren’t familiar with market mechanics or the way buyers and sellers interact with each other. It’s a pretty competitive environment for individuals taking their first step into the financial world. To help you flatten the learning curve, discover and understand all the information you will need to become a successful trader, we’ve compiled a list of 10 day trading rules and strategies you should start with.
The list includes everything from how to create and validate a trading strategy, to what to look for when choosing a brokerage company. It also includes some crucial points like how keeping a trading journal helps improve your efficiency, what is the best way to plan your entry and exit points, and why it is so important to teach yourself self-discipline and learn how to control your emotions. By adhering to those essential principles, you will make significant progress with minimal effort.
After you go through our comprehensive list of top day trading rules and strategies, you’ll have a better understanding of what it takes to be involved in day trading and how to better navigate the market. More importantly, you’ll have an idea about how to start your day trading career: open a demo account where you can try out different trading scenarios, learn capital allocation rules, and develop sustainable risk management strategies.
This is among the most crucial day trading rules. As the saying goes, hope for the best, but plan for the worst. You should always assume that the trade you are about to open will likely lose. Even if you think it has a high probability of it being a winner. It may sound cliché, but when it comes to day trading, not having a detailed plan that marks your exit if the trade goes against you or when you reach your profit target is equal to planning for failure.
The plan to exit the market should come before you decide at which price you will buy or sell the asset. Moreover, the plan shouldn’t be based on a whim. There should be some sound reasoning behind why you want to enter and exit a trade. That is why having a detailed and time-tested trading strategy that has proven to work in various market conditions is the key to become a successful day trader.
Most day traders apply technical analysis-based trading strategies because short-term time frames are not suitable for fundamental analysis. Hence, day traders like to draw horizontal support and resistance lines based on historical price action to know where a trend might find an obstacle in the near future.
One way to plan an exit even before entering a trade is to find the nearest support and resistance levels. Once you have a basic idea about where the trend might start a retracement, you can plan your entry and exit more accurately.
In figure 1, we can see that the EUR/USD was range-bound. If you are a price action-based day trader, you might have wanted to trade after the bearish pin bar formed. In this example, your exit plan would be above the previous resistance, at 1.1230, if the trade turned against you. By contrast, you would reduce your exposure or completely exit the market with the gained profit once the price reaches the well-defined support level around 1.1165.
2. Fine-Tune Your Trading Plan and Optimize Your Strategy with Virtual Money
If you are reading this article, then there is a good chance that you are just starting as a day trader. As a novice trader, you need to understand that day trading is a serious business. Some of the best and brightest minds in the world end up trading in the financial markets, and it is a very competitive place to be in.
You might be pretty good at your profession, but if you suddenly wake up one day and decide to do some day trading to pay for kitchen remodeling or taking that dream vacation, it might not work out as you planned.
To consistently beat the market, first, you need a detailed trading plan or strategy that works. Then, you need to master that strategy and practice trading for several months before you should even consider opening a live day trading account.
Open a demo trading account and paper trade the rules of your trading strategy meticulously.
Learn to place entry orders only when all the conditions of your trading strategy have been met.
Become proficient in ending the trade with either small losses or enough profits.
To practice, you should open a demo trading account and paper trade the rules of your trading strategy meticulously. Learn to place entry orders only when all the conditions of your trading strategy have been met and become proficient in ending the trade with either small losses or enough profits.
The key problem novice day traders face is the age-old dilemma of submitting to fear or becoming too greedy. Day trading with a demo account should help you learn how to cut your losses short, according to your strategy and money management rules. Furthermore, it should make you understand that you should exit the market with ample profits once the reward to risk ratio of your trade has met, which should be already predefined in your trading strategy.
Demo trading will also help you get familiar with the adrenaline rush of the trading environment. A lot of day traders end up overtrading as the experience is often addictive. However, to become a successful day trader, you should learn to differentiate how to be a healthy trader who follows their strategy and what constitutes the behavior of a gambler. The vast majority of day traders end up gambling away their precious capital. After all, the short-term excitement of trading can easily dominate long term profit motives.
Learning the concept of when you have earned enough profit and when to stop trading for the day will serve you well as a day trader in the long run. There is no better way to achieve this objective than to trade with a demo account.
3. Time The Market And Know When To Trade
The global currency market remains open 24 hours a day and five days a week, but when it comes to trading futures, you should stick to trading only when major futures exchanges are operating.
Figure 2: Global Financial Centers on the World Map
That said, there is the pre-market for futures trading around 30-minutes before the actual market open hour, and on the other side, the after-hours futures markets remain open even after the official cash markets are closed. However, pre-market and after-hours futures trading usually lack price volatility due to low trading volume. Furthermore, if you trade during the off-market hours, you will probably have to deal with a lot of price gaps and large price spikes.
To earn a profit from day trading, there should be ample volatility in the market. Without major price movements, you wоn‘t have the opportunity to buy or sell for profit. That’s why knowing when to trade is crucial to becoming a successful day trader. Depending on your time zone and availability during the workday, choose a block of time that is in sync with one of the major financial centers worldwide.
For example, if you are trading currency futures, trading when the Chicago Mercantile Exchange (CME) is operational would help you find more trading opportunities compared to off-market hours. After all, it has an average daily trading turnover of over $100 billion, making it the second-largest market for foreign exchange only after the interbank global spot market.
4. Start a Trading Journal and Make Reviewing Your Trading History a Habit
We can only learn from our experience if we remember it, right? When you are making ten trades a day, it is easy to forget what circumstances you opened the trade or even why you made any profits or losses from it.
Trading history, however, isn’t only about entry and exit price information. There are also stop losses, profit targets, trading volume, patterns, and other factors that have shaped your trading decision. You should keep a record of all of them.
Also, consider writing down the state of your emotions at the time. Once you have placed the order with your broker and the trade is in progress, write down how you reacted when it tested a support or resistance level. Did you feel like taking the profit and closing your position? Or did you feel like moving your stop-loss order further to give more breathing room to your trade?
“Losses are necessary, as long as they are associated with a technique to help you learn from them.”
― David Sikhosana, Time Value of Money: Timing Income
Small details like this will help you understand how your mind reacts to the market situation and make you a more disciplined trader who sticks to their trading strategy.
Figure 3: Keeping a Trading Journal
Using free software like Microsoft OneNote or even a Google Doc file with charts and annotations would do just fine. At the end of every week, summarize the events from the past seven days. The summary should include both your wins and your mistakes. For the latter, consider also including your thoughts on how you should have reacted to avoid them.
The market moves very fast when you are day trading, and you have to make split-second decisions. The point of keeping a trading journal is to train yourself on how to stick to the trading strategy under pressure. If you can master the art of writing and reviewing a trading journal, you can reduce your learning curve and become a successful trader much faster.
5. Focus On Using Limit Orders
Once you have mastered keeping a trading journal, you will understand why it is not worth it to chase a trade. Instead, you will be more patient and let trading opportunities come to you. When you first encounter the chaos of day trading, you will feel the need to be a hunter. You will feel that you need to be a go-getter who actively looks for trades and jump the gun the moment there is an opportunity.
However, experienced traders know that there is no point in chasing the market. If you miss an opportunity, another one will arise very soon. Hence, it is much wiser to stick to your initial day trading strategies. You will realize that you should only enter the market at the price point with the highest reward to risk ratio according to your trading strategy.
As a novice day trader, you are used to placing market orders when opening new positions. A market order is an instruction to your broker to open a position at a “market price.” The problem is prices change quickly. You have no idea what price the broker will fill your order at.
Let’s say you wanted to buy 20 CME December 2019 contracts of CME Euro FX contracts at a price of 1.1550 and sell it at 1.1600. So, each $0.0001€ change in price would result in a $12.50 profit. At 125 000 Euros for each Euro FX contract, your profit would have been $0.0050€ x 125,000 x 20, $12,500.
However, if you use a market order and your broker filled it at 1.1552, you would lose out around 4% of the profit (or $500 approximately). The only way to avoid such a situation, in the long run, is to use limit orders. Sure, you might miss a trading opportunity once in a while, but the performance of your strategy will significantly improve.
6. Stick To Your Trading Plan
Before you start day trading, you should backtest then forward test your trading strategies to the point that you know for certain that they work. Make sure that over the course of 100 trades, your strategy allows you to win enough to offset the losses and still generate a profit.
Once you establish the trading rules and strategies, you will adhere to, test how many losing trades they produced in a row and keep a note of the number. For example, your strategy might have produced six consecutive losses during forward testing. When you start applying your trading strategies in a live account, however, you end up losing on three trades in a row. Naturally, you would start to doubt its validity. After all, who wants to throw good money after bad money and keep trading a strategy that is not working?
Keep in mind no strategy works 100% of the time.
Over a course of hundred trades you still should have some profit to make it worth your while.
Keep a record of your losing streaks.
When you are in doubt (you lose 6 or more in a row) find trades that are in line with your strategy.
In case of longer losing streaks (10-15 in a row) examine the market structure and and fine-tune your strategy.
Never discard a proven strategy after a few losses.
If you end up taking a few losses, instead of switching strategies immediately, review your trading journal to see if you followed all the rules.
“The minute you get away from the fundamentals – whether it’s proper technique, work ethic, or mental preparation – the bottom can fall out of your game.”
― Michael Jordan
If you keep losing after 10 to 15 trades, you should start evaluating if the underlying market structure has changed and figure out what went wrong. Maybe you were curve fitting when backtesting or had exceptionally good luck during forward testing. Go back to the drawing board and figure it out. In the end, however, avoid strategy hopping or ending up trading five days of the week with five different strategies.
7. Trade Capital You Can Afford Losing
This is among the no-brainer rules and should not require too much convincing for the idea to sink in. If you risk the money that you need for next month’s rent, you will make irrational trading decisions. If you have a 30 pip stop loss, the loss aversion psychology will prompt you to move your stop loss to -300 pips. Because the moment you close the trade, you will realize the loss, and you cannot accept taking a loss with money you need to survive.
Trading is a business and not a get-rich-quick scheme. You should only trade after you have enough money to sustain your current lifestyle for at least several months. Moreover, meet all of your financial obligations, fund your retirement account, and be financially secure before considering becoming a day trader.
Unless you are financially secure and only invest money that will not affect your sleep if you lost it, you will never be able to become a disciplined trader and end up losing the little money you have saved up. So no, never trade a dime that you might need within a short period of time. Only invest what you can consider something you can take risks with.
8. Be Careful With Margin Trading
Before starting with day trading and thinking about any strategies, you should make one thing clear to yourself – your profit will depend on the number of trades you make, rather than the individual return from each of them. Or, in other words – you will be profiting from scaling your activity. In most cases, the returns on a single trade won’t be significant. These are the rules of day trading which you should accept and not try to rewrite by taking advantage of the easiest cheat code available – trading on leverage.
Don’t forget that margin trading is a speculative practice and can be very dangerous if not applied carefully. Make sure to turn your focus to day trading on margin only when you have enough experience and a well-working strategy. You should be aware of all the pitfalls and be extremely cautious.
The history knows a plethora of cases where traders have not only wiped out their entire portfolios but have also ended up in debt to their brokers due to a single trade gone wrong when trading on leverage.
“Warren and I are chicken about buying stocks on margin. There’s always a slight chance of catastrophe when you own securities pledged to others. The ideal is to borrow in a way no temporary thing can disturb you.”
― Charlie Munger
But let’s talk numbers. Day traders are typically allowed to borrow up to 4 times the amount they have deposited into their trading accounts. So, in this case, if you have a trading capital of $5,000, you will be able to buy instruments worth up to $20,000. Bear in mind that price changes are also multiplied by four here, which means you can get a margin call very quickly if the market turns against you.
For day traders who keep their open positions overnight, the limit is two times. Read more on FINRA’s terms here. However, these requirements may differ depending on your jurisdiction, the type of trading activity (swing or position traders, for example), brokerage company, etc.
Don’t forget that trading is a consistent process and not a shortcut to making a fortune quickly. Don’t try to turn it into such or rely on margin trading as a ladder to becoming a millionaire overnight.
Of course, margin trading also has lots of positives. Trading on leverage is a great tool for those who know what they are doing. Seasoned day traders with time-tested risk management strategies, for example, apply it successfully to amplify their profit opportunities.
9. Find The Best Brokerage Service Provider
If you are an active trader, then you are probably familiar with what you need from your broker. If you are a beginner, on the other hand, you should pay significant attention to the next few paragraphs.
There are a lot of brokerage companies worldwide, which may further complicate your choice. What is important to consider when deciding who you should go with, however, is to look at several key factors.
The first is the financial terms, including trading costs, margins, and account minimums. Look at the margins and the fees that you will be charged on each trade. This is particularly important when day trading, as you will be placing a significant amount of trades per session. The good thing is that many popular brokerage companies currently offer commission-free trading. Make sure to go through their terms, do your research, and find the most cost-efficient solution. Don’t forget to consider whether there is an account minimum as well. Luckily, there are lots of brokerage platforms that won’t make it hard for you to start (considering you adhere to the regulators’ requirements).
Next are the features, functionalities, and trading perks. The platforms of the best service providers offer high-speed trade execution, reliability, and advanced trading features. These include uploading trading bots/algorithms, built-in charting and analysis features, premium research functionalities, mobile apps, news decks, and more.
There are plenty of viable service providers that you can choose from. The most popular include Interactive Brokers, TradeStation TD Ameritrade, Fidelity, ETrade, Charles Schwab, and more. Make sure to go through their Terms and Conditions to find out if there are any limitations depending on your country of residence, account minimums, margin trading requirements etc. Basically everything that can affect your day trading activity. Last but not least, make sure to try out their platforms and test the supported features.
10. Don’t Take Yourself Too Seriously
We have already highlighted the importance of sticking to your pre-defined trading rules and plans even when things go wrong. But it is also very important to analyze the reverse situation when we have a series of winning trades, as well.
When we are on the losing side of a trade, we are all the same. It is when we are winning that you can differentiate the day traders that are more likely to be successful in the long-term.
Although films like Wall Street or the Wolf of Wall Street have shaped the idea of traders being arrogant, cocky, alpha-males who can sell anything to anyone, when it comes to day trading and modern markets, things are just the opposite. Today, no one cares how convincing you sound, whether you are Jordan Belfort or the perfect salesman.
The digital financial market landscape today presents everyone with equal opportunities (with small exceptions for high-frequency traders or sophisticated prop trading companies). That is why it is only the disciplined ones who succeed.
The main distinguishing factor between beginner day traders and seasoned veterans is their state of mind and behavior when on the winning side of a trade. Often, when some beginners make a series of profitable trades, they tend to get overconfident. Most of the time, however, it is just luck or market momentum. Seasoned veterans, on the other hand, are familiar with the dark side of the markets. They had been on the losing side numerous times, which is why they realize no one is good enough to beat the market 100% of the time.
Bear in mind that when you are starting, even if you end up making a series of successful trades, you should remain true to your strategy and avoid acting on other signals. If you want to keep being successful in the long-term, learn to manage the risk of overestimating your skills, and overrating your trading strategy.
“Novice Traders trade 5 to 10 times too big. They are taking 5 to 10% risks on a trade they should be taking 1 to 2 percent risks.”
― Bruce Kovner
The Bottom Line
If you are just starting out as a day trader, know that it will be a long road before you will become a profitable trader. However, these 10 rules will certainly help you jumpstart your career. Once you are ready, take the next step and start The Gauntlet Mini™ here to prove your trading skills and become a professional trader.
Finally, don’t forget that we are all Warren Buffets when markets move in our favor. It is what we do and how we behave when the trend goes against us that matters.