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There is no denying that long-term buy-and-hold investing can produce remarkable results. Berkshire Hathaway is the best example of this. I am a day trader and find value in long term investing. Since I only need to focus on day trading, I have an investment advisor who manages the long-term portion of my portfolio.
The contrast between what he does and what I do could hardly be greater: my average time holding a stock is five minutes, and sometimes I stay in a stock for a few seconds. With these waiting times, it doesn’t take long to find out if my investment strategy was right, wrong, or completely wrong.
It’s no exaggeration to say that day trading can be like squeezing a lifetime of investing into one year. I have made over 20,000 trades so far and plan to continue trading for many more years.
Two common phases that day traders go through
The first stage is beginner’s luck. I actually think it’s a day trading thing and I’ve experienced it myself. In my first year in business I made about $30,000. I was thrilled! Yes, it was work, but it was definitely better to pump gas, which I had done a few years earlier, or work for a short-tempered boss, which I also knew about.
Over the years, I’ve heard enough similar stories from other traders to believe that beginner’s luck is quite common. However, a harsh reality always waits in the wings for those happy beginners, and it even has a name: regression to the mean.
After my second year of trading, I gave back the initial gains and was now breaking even. But in my third year of studying and working hard at trading, I wish I could say I’ve turned the corner, but I haven’t. I lost a lot of money and had one last chance left before I had to get a “real” job.
Some people can look back at turning points and identify a mentor who said the right thing or a chance encounter that made a difference. In my case, keeping a journal of all my trades saved my day trading career. I recorded not only the trades but also my strategy at the time I made the trades. By analyzing that journal, I identified a trading pattern that led to losing trades and a different set of characteristics for my winning trades. With this knowledge, I turned my ship around.
This brings me to the second common stage, “investment friction.” Sometimes, when day traders suffer a major loss, they fear taking more risks. They become mentally trapped and it becomes more difficult to regain trading confidence. It can be the start of a downward spiral.
But here’s the really interesting thing: the same phenomenon sometimes happens with winnings. After a particularly memorable win, traders will retreat and place progressively smaller trades.
Back to my trading diary: There are about 250 trading days in a year. I have found that my first 10 days of trading usually account for over 20% of the entire year’s profit. In those golden days, am I simply throwing caution to the wind? No, and this is where the flight analogy comes in.
Related: How Cognitive Biases Can Impact Trading and Investment Decisions and How to Reduce Their Effects
Trust your tools
When you learn to fly, you only practice on days with good weather. You are operating under so-called “visual flight rules”. But if you stick with it, you’ll learn the “Instrument Flight Rules.” Once you are allowed to fly under these rules, the good news is that you will be able to fly in any weather condition. The bad news is that you have to ignore your instincts and learn to trust your tools, otherwise you will end up falling apart.
The same goes for day trading. Successful day traders are not gamblers or cowboys, but rather expert pilots. They perform a profit and loss calculation before undertaking a trade. They will see a recognizable pattern in the stock price behavior, including other factors such as trading volume, company news, and so on. If the numbers add up, they accept the exchange.
The next part is where successful traders make money: they stick to the parameters they set. This means that if the stock goes up, they have a process to take some profits off the table while letting the stock continue to go up. But if the stock starts to fall, they don’t let it go “a little longer,” hoping it will reverse. Instead, they sell without hesitation and limit their loss.
In any case, they trusted their tools and would live to trade another day.
Related: Day Trading: How to Get Started
Don’t get me wrong: even after 20,000 trades, I can control my emotions and trade based on my tools. It never gets “easy” because I can always follow my own parameters. Sometimes, emotions get the best of me and I think: What just happened? So, my journal review will reveal that my emotions got the better of me that day for that exchange. It’s then my turn to become more disciplined in the heat of the moment, then apply what I learned from that last trade.
There is no way to turn day trading into a foolproof system for making profits. You can increase your chances of doing well in this unforgiving environment. You can achieve this by doing three things:
- Record what you were thinking at the time and how it worked;
- Analyze that transaction and how you might change your parameters in the future; AND
- Have the discipline to stick to those course corrections the next day.
There is no guarantee of profit, but it is the only way I have found to stay in this profession long term.