Would you like to know how day traders do it? How day traders decide what stock to buy? These are the questions asked of a day trader.
I will attempt to shed some light on the subject, although, it is similar to asking a heart surgeon, how he performs open heart surgery. (day traders think highly of the profession). Stocks are grouped into three categories.
- Stocks that are outperforming the market.
- Stocks that are trading in perfect correlation to the market
- Stocks that are under performing the market.
Investors look at this information on a longer time frame than a day trader. A day trader will look at the stocks performance for the past hour, day or week. An investor will look at the stocks performance on the month, quarter, or year.
A large percentage of stocks trade in almost perfect correlation to the S&P 500. This means, if the S&P is up 7% on the year, most stocks will also be up 7%. Interestingly enough, this also happens on a daily basis. Unless there is new information released about an individual stock, like an earnings announcement or a new product release, the stock will usually follow the market. If the stock is outperforming or under performing the market, there should be a reason why.
Many day traders look for stocks that are up or down sharply in the pre market and trade those stocks during the day. A stock that opens for trading at 9:30 and is already up 10% will usually fluctuate a few percentage points during the course of the day.
Google is a stock that usually trades along side the Nasdaq. When the Nasdaq goes up, so does Google, and vise versus.
Sept 1st, 2010 was a rocking day in the stock market. The S&P opened up 9 points and finished the day up 31 points!
Here is the Nasdaq 100 1 day, 5 minute chart:
Here is the Google 1 day, 5 minute chart:
(The times on the two charts above are different because of time zones, the Nasdaq 100 is GMT -6 (Chicago) and GOOG is GMT -5 (new york))
At 10:00 am New York time, the Nasdaq jumped and so did Google (see chart below). The problem was that Google, did not move as high as the Nasdaq. With Google up 1.5% and the market up 2.5%, Google had a considerable amount of catching up to do.
A day trader who is familiar with a stock like Google will say, it is only a matter to time, 5 minutes, 10 minutes or maybe an hour until Google catches up to the Nasdaq. The trader will buy Google and wait for the price to go up the same percentage as the Nasdaq is up.
A pair trade would be to buy Google and short the Nasdaq and wait for the correlation to revert back to the norm and make 0.50%.
For some reason, I decided to buy Google at 10:03 for $457 and hold onto it for 42 minutes until it reached $462 . At 10:45 when I sold GOOG, I had made my 1% return and the correlation between Google and the Nasdaq was coming together. So why didn’t I wait until 11:00 or 11:45 when $GOOG and the Nasdaq where both up 2.8%? Because sometimes you take your profits early and are happy with 1% in 42 minutes.
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