Day trading 101

18 hours ago
4 min read

When you start learning to trade, you'll be bombarded with information. Successful trading requires you to master certain concepts and strategies. Information often comes in fragments, spread across various lessons and instructional videos, so I thought it would be helpful to summarize some basic concepts.

Candles/wicks

The basics of trading. The candles show how much the price has moved and in which direction on each time frame. Green candles indicate that there have been more buyers in that time frame, also called a bullish candle. Red candles indicate that there have been more sellers in that time frame, also called a bearish candle.

The candle itself consists of two parts: the body and the wick. The body is the thick, colored part. The top of a green candle indicates the price at which the candle closed. The bottom indicates the price at which the candle closed. For a red candle, this is the exact opposite.

The wicks or thin sticks indicate within which range the price has moved.

Some candlesticks have been given exotic names like doji and harami cross. Both are candlesticks with small bodies and short wicks. This means that neither buyers nor sellers have the upper hand. This often signals a reversal in the price direction.

Then there's the hammer candle. As the name suggests, this candle resembles a hammer. So, a small body with a long wick. It's also often an indicator of a price reversal.

Support and resistance levels

These are levels where the price remains stuck. In the image above, they are the yellow lines. If the price tries to break upwards but stops at that line, it's resistance. If the price tries to break downwards but stops at that line, it's support.

As a trader, you are looking for candle patterns that break through those levels, which could indicate a possible entry.

Based on these two concepts, you can actually start trading. By looking at the candles, their shape, and where they break through levels, you could potentially place a trade. However, that's not the whole story. More indicators and strategies are involved in placing a successful trade. Otherwise, you're just following the market, which can reverse just as quickly. Without a plan, it's essentially just gambling. This might work sometimes but it will fail 90% of the time.

This brings me to the next point: risk management.

Risk management

With good risk management, you try to maximize your profits and limit your losses. You're always looking for at least a 1:2 risk/reward ratio. So, you bet $20 with the goal of winning $40.

Risk unit

The $20 amount is called a risk unit. The size of that risk unit (RU) is related to a percentage of your account value.

As a rule of thumb, that's 1 to 2% of your account value. So:

Account value: $1000 RU 1%:$10 RU 2%:$20

A $10 RU means you can lose 100 trades before your account is depleted. A $20 RU means 50 losses. In practice, you'll never lose 100 trades in a row unless you're truly gambling and not following a plan.

As a beginner, I'd stick with the lowest RU since you're still learning how trading works. You don't recognize patterns yet, you don't have a solid strategy, and you're falling prey to FOMO and revenge trading.

You should be able to absorb those losses without blowing up your account.

Risk/reward

The ratio of loss to profit. How much are you willing to risk for a certain target profit?

You're always looking for at least a 1:2 risk reward ratio. This means you need to be right 50% of the time to be profitable. So, you'd rather aim for a 1:3 risk reward ratio. That way, you only need to be right 30% of the time to be profitable.

And now trade!

You've now mastered the basics of trading and risk management. But $1,000 in trading capital won't get you far. Stocks range in price from a few dollars to tens of thousands.

That's why funded accounts exist. For example, with $1,000, you can buy an account with $30,000 in trading space. Your RU is always based on the value of your account, not the trading value. Funded accounts often have a drawdown, or extra space you can trade beyond your account value without having to pay that loss.

I'm sitting on a 45k account that I bought for €1300 with a drawdown of €2000. So my RU is $20 or a multiple of that, depending on how much risk I'm willing to take.

For good risk management, you will encounter the following concepts because you do not enter a trade without first covering your losses and knowing whether you can achieve your intended profit.

Entry

The price level at which you enter a trade.

Take profit (TP)

the price level at which you take your profit.

Stop loss (SL)

The price level at which you are willing to take risks.

Suppose you enter a trade at a price level of $250. You want to risk 1 RU for this trade, in my example $20. Your stop loss would then be $250-$20=$230. With a risk/reward of 1:2, your take profit would then be $250+$40=$290.

Conclusion

I've covered all the basics, but there's much more to placing a successful trade. Mindset, psychology, and strategy are actually the most important aspects of placing a successful trade. Always remember that even with a good setup, you can lose! After all, it's still speculation about the likely direction a stock will take. However, with different strategies, you can determine with greater certainty whether a trade will go your way.