Certain rules that can help you in selection of stock for day trading are discussed here. These rules can be digested quickly to help you avoid the biggest pitfalls in trading. These rules include:
- Trade liquid stocks
- Avoid unpredictable (chaotic) stocks
- Trade stocks with good correlation
- Move with the trend
- Research
1. Trade liquid stocks
It is often said that liquidity is like oxygen to traders; without it, they are dead. Thus liquidity is the first and most important rule while selecting a stock for day trading.
A liquid stock is one, which has a high average trading volumes, so that it can be bought or sold in sufficient quantities without causing much impact on the prices.
It is advisable to day trade strictly in liquid shares less liquid stocks helps a trader buy or sell large quantities of shares without any problem of there being no buyers or sellers. While it could be argued that illiquid volatility also creates opportunity through rapid price change, statistics prove that volatile shares move the most in the least amount of time. Therefore, most opportunity dissipates while downside risk looms.
However, this is not a hard and fast rule, as the amount of liquidity depends on the quality of your trade.
Suppose you buy few shares, say 50 to 100 shares, then shares with average trading volume of 50,000 to 75, 000 will suffice, whereas if you buy few hundred or thousand shares then you need a stock with average trading volume of few lakh shares.
Some of the examples most liquid stocks include Reliance Industries, SBI, Infosys, ONGC etc.
2. Avoid unpredictable (chaotic) stocks
Generally it is seen that stocks that are trading with low average daily volumes or stocks where some big news is soon expected, tend to trade in a highly unpredictable manner. Sometimes even after an important announcement -- which may be either good or bad (like big order, good results, bad results, plant shutdown etc) -- the stock may trade in a chaotic manner. So it is advisable to avoid such chaotic stocks.
Some of the mid caps, and most of the small caps especially those in S, T and Z group are chaotic stocks; better not to trade them from intraday point of view. They also have very low volume thereby increasing their unpredictability.
3. Trade stocks with good correlation
It is advisable to trade in stocks that have more in correlation with major indices and sectors. That is if the index or a sector moves up the stocks belonging to that index or sector also moves up and vice versa.
Stocks that track and trade in correlation with the group (sector) to which they belong are more readable & reliable, so that if any good/bad news comes in, affecting the sector as a whole, then you can depend on the stock to move in the manner as the overall sector is expected to move.
For instance, if the Indian rupee strengthens against the US dollar then all IT companies depending on US markets get adversely affected.
A stronger rupee means these IT companies will earn less from their exports. Conversely rupee weakening against the dollar leads to increase in their export earnings.
4. Move with the trend
It is always easier to swim along the river rather than across it. Always remember this thing while day trading.
If we are in a secular bull run, then it is advisable to find stocks (sectors) that are going to rise, rather than finding stocks (sectors) that are going to fall.
Similarly if we are in a bearish phase, then it is advisable to find stocks (sectors) that are going to fall, rather than finding stocks (sectors) that are likely to move up.
5. Research
Quality research is the key to success. However, it is generally observed that day traders hardly do any research.
First, identify an index (like the BSE Sensex or the NSE Nifty) that fits your style of trading and then identify sectors within this index that appeal to your interest. Next step is to create a significant list of stocks within each such sector. Note that stocks in the sector need to be leader of that sector, and should be most tradable.
Daily analyse these stocks technically to decide whether they will move up or down the next day. You also need to find out a particular stock's key levels of support and resistance. Is the stock overbought or oversold? Has volume been showing any significant changes?
Also study the fundamentals of the companies and try to know when they declare their quarterly results. Studying how a particular stock moves on the day before the result, when the result is announced and after the result helps a day trader understand how the market reacts to results.
The article is an excerpt from the book Guide To Intra Day Trading (http://books.rediff.com/bookshop/bkproductdisplay.jsp?Guide-to-Intra-Day-Trading-English-Books&prrfnbr=82596456&multiple=&frompg=_), authored by Jitendra Gala & Ankit Gala and published by Buzzing Stock Publishing House (http://buzzpublishing.net/shop/product_info.php?products_id=63), Mumbai.
