Ray Barros, in his post Day Trade?, brings up the subject of why people choose to become a day trader rather than a swing trader or a position trader. He notes that many do so because they believe themselves undercapitalized for holding positions overnight. I would add in another view I’ve heard on quite a few occassions. Many day traders don’t want to risk the relatively large number of points or pips implied by by trading in those longer timeframes. Ray thinks the undercapitaliation argument is a poor one, and I agree. I also think the point/pip one is foolish, and I’m guessing Ray would agree with me there.
If you are going to day trade you should do so because that’s the timeframe which makes the most sense for you.
It’s about being at your most effective. Effective day trading requires the ability to dedicate sufficient time to the market on a consistent basis. Those hours in the market should be during a regular time of day and should be at a point when there’s enough going on most days to provide you the opportunities you require. If you want to trade forex, for example, and the only window you have is from 4-7pm NY time each day, you’re probably better off considering other options.
Is capitalization an issue? Absolutely. But I actually would spin things around from what Ray mentioned above about people picking day trading because they didn’t think they had enough money to trade overnight.
If you don’t have sufficient capital to handle an overnight position then I would contend you probably shouldn’t be day trading either.
Why? Because it implies that you are probably trading at too high a risk level. Consider the example of someone daytrading the mini S&P 500 contract. That could be done on margin of around $1200, compared to something like $4000 for an overnight hold. What does your risk look like if you aren’t funded enough to carry a position overnight?
The point value of a mini S&P contract is $50. If you have a $5000 account, a single S&P point is 1% of your portfolio value. Now, if you’ve only got $2500 in the account to day trade, that point is 2%. How much are you willing to risk on a given trade, because a one point risk is a very small one in the S&Ps, especially in the current market environment. A quick look at the Average True Range (ATR) tells me that at this writing the lowest 10-minute average range over the last week has been about 2.5 points. A one point stop would almost certainly get hit.
Add the increased transaction costs from high frequency trading to the excess risk being taken and you get a recipe for poor performance. That’s why I don’t think low capitalization traders should be day trading.
Of course, if you’re trading forex where some brokers have no minimum position sizes, then it’s a different story all together.
It’s worth noting that you are always going to be better off with more capital. A larger account balance gives you more options.
As for the number of pips or points you would have to risk to trade in a longer timeframe….
Risking 10 points is the same as risking 1 point if you are sizing your positions to risk a specific % of your portfolio.
I’ve seen even some experienced traders say they don’t position trade because they don’t like the idea of taking the bigger risk. It’s only bigger risk if you don’t adjust your position size accordingly. You cannot get caught up in the number of points or pips in the trade. They are basically meaningless. Think in terms of percentages and you’re better off.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
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