8 Common Rules for Picking Day Trading Stocks

Day trading is a fast-paced form of stock trading where shares are bought and closed within the same trading day, often within hours or minutes and sometimes within seconds. This strategy is focused on capitalizing on small, rapid price movements in highly liquid stocks. While day trading can offer substantial profits, it also comes with significant risks, which many day traders try to mitigate by closely following rules and strategies. Adhering to a system can help traders navigate the volatile market without reacting emotionally and improve their chances of making successful trades.

If you want to grow your investment portfolio, a financial advisor can help you create a plan.

Day Trading Basics

Unlike long-term investing , which depends on holding assets for months or years while generating income and price appreciation, day traders seek to make money more or less immediately by capitalizing on small, intraday movements in stock prices. This investment strategy requires a deep understanding of market trends, quick decision-making and the ability to execute trades swiftly.

The time frame is a key trait distinguishing day trading from other forms of trading. Day traders typically hold positions for minutes or hours, but never overnight. In addition to being different from long-term investing, this approach contrasts with swing trading , where traders hold positions for several days or weeks to take advantage of broader market trends.

Day traders rely heavily on technical analysis , using charts, indicators and patterns to predict short-term price movements. They often focus on stocks with high volatility and liquidity , as these provide the best opportunities for finding and profiting from rapid price changes.

While day traders seek volatility, trading in stocks experiencing rapid price changes also exposes them to higher-than-average potential for losing money. The Securities and Exchange Commission has long warned that day trading is a high-risk activity , and that most day traders experience severe financial losses when getting started and many never make money. When traders leverage investments by purchasing shares with borrowed money, it can increase profit potential but also raises the risk level.

The high-risk nature of day trading means that it requires strict discipline, careful risk management and a well-thought-out strategy. To encourage this, day traders often set rules for themselves to follow.

8 Common Rules for Picking Day Trading Stocks

Making money with day trading begins with selecting the right stocks. Here are eight common rules that day traders follow when picking stocks to trade:

1. Focus on liquidity: Liquidity refers to how easily a stock can be bought or sold without affecting its price. Day traders prefer highly liquid stocks because they can enter and exit positions quickly without causing significant price changes. Stocks with high daily trading volumes, typically in the millions of shares, are ideal candidates for day trading.
2. Look for volatility: Volatility measures the extent of price fluctuations within a stock. For day traders, volatility is essential because it provides opportunities to profit from short-term price movements. Stocks that experience significant price swings throughout the day are more attractive to day traders than stable, less volatile stocks.
3. Choose stocks with a high relative volume: Relative volume compares a stock’s current trading volume to its average volume over a specific period. A higher relative volume indicates increased interest and activity in the stock, which can lead to greater volatility and better day trading opportunities. Day traders often look for stocks with relative volume ratios of two or more, signaling heightened activity.
4. Pay attention to news catalysts: News events, earnings reports and other market-moving announcements can create significant volatility in stocks. Day traders often monitor the news for events that could trigger sharp price movements, such as mergers, acquisitions or regulatory changes. Trading stocks with recent news catalysts can provide opportunities for quick profits.
5. Set clear entry and exit points: Successful day traders establish clear entry and exit points before executing a trade. This involves setting price levels at which they will buy or sell a stock, as well as stop-loss orders to limit potential losses. By defining these points in advance, traders can avoid emotional decision-making and stick to their strategy.
6. Use technical indicators: Technical indicators , such as moving averages, Relative Strength Index (RSI) and Bollinger Bands help day traders identify potential entry and exit points. These indicators provide insights into price trends, momentum and overbought or oversold conditions. Using a combination of technical indicators can improve the accuracy of stock picks.
7. Monitor the market sentiment: Market sentiment refers to the overall attitude of investors toward a particular stock or the market as a whole. Day traders keep a close eye on market sentiment indicators, such as the VIX (Volatility Index) or sentiment surveys, to gauge the mood of the market. Positive sentiment can drive prices higher, while negative sentiment can lead to sharp declines. Understanding market sentiment helps traders align their trades with the broader market trend, increasing the likelihood of successful trades.
8. Check the stock's float: A stock's float refers to the number of shares available for trading by the public. Stocks with a low float can be more volatile because fewer shares are available to trade, which can lead to more significant price movements when there's strong buying or selling pressure. Day traders often look for low-float stocks because the limited supply can lead to sharp price increases, especially if there's a catalyst driving demand.

Bottom Line

Day trading requires a disciplined approach, thorough research and a deep understanding of market dynamics. Day trading is inescapably risky due to the potential for losing money by trading in highly volatile shares. By following common rules for picking day trading stocks, such as focusing on liquidity, volatility and technical indicators, traders can improve their chances of success in the fast-paced world of day trading.

Tips for Investing

• A financial advisor can help you analyze investments and manage your portfolio. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .
• Income generated from day trading may be subject to capital gains taxes. Check the amount of capital gains tax you may owe using SmartAsset's capital gains tax calculator .

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