Choosing Stocks For Day Trading – A Guide For Beginners

5 steps to choosing stocks for day trading

Step 1 – Evaluate your financial position and objectives

Before you dive into the world of day trading, it's imperative to lay a solid foundation by carefully assessing your financial circumstances and establishing clear objectives. This initial step serves as the bedrock for your day trading journey. This step can be broken down into two key considerations:

• Capital Allocation
  Determine the amount of capital you are willing and able to allocate to day trading. This is not just about what you can afford to invest, but also what you can afford to lose entirely. Day trading carries substantial risk, and there are no guarantees of profit. It's crucial to segregate your trading capital from your everyday funds, ensuring that your financial security and obligations are not compromised.

• Risk Appetite
  Understanding your risk appetite is paramount in day trading. It entails assessing how comfortable you are with market volatility, potential losses, and the emotional roller coaster that comes with trading. To gauge your risk tolerance, consider your psychological preparedness for the inevitable ups and downs of the market. Different traders have different levels of risk tolerance, and this should guide your choice of stocks and your overall trading strategy.

Step 2 – Undertake research and analysis

As a day trader, time spent on research and analysis post market hours is crucial. Most seasoned traders choose their day trading stocks based on post-market research and analysis. Experts suggest considering the following key aspects in this area:

• Market trends
  It's crucial to stay updated on current market trends and the macroeconomic factors that impact stock prices. Regularly follow financial news and consult reliable sources for insightful market analysis.

• Industry analysis
  Understand the dynamics within the industry sectors you intend to focus on. Each industry has its unique characteristics and risk profiles, which should influence your stock selection.

• Company financials
  Take a close look at the financial health of the companies you plan to trade. Analyze key financial statements like income statements, balance sheets, and cash flow statements. Evaluate the factors such as profitability, debt levels, and growth prospects.

• Earnings season
  Being cautious during earnings season by keeping track of earnings release dates and economic calendars can often turn out to be rewarding, mainly because earnings reports can significantly sway stock prices. So, seasoned traders often plan their trades strategically around these events to minimize surprises in the market.

After careful consideration of all these factors, shortlist the stocks that tick most of the boxes as per your trading strategy for the next trading day.

Step 3 – Consider volatility and liquidity

Two critical factors that day traders closely consider when selecting stocks are volatility and liquidity. Experts have discussed them in isolation as follows:

• Volatility
  Volatility measures the extent of price fluctuations in a stock. Day traders often favor stocks with higher volatility due to their potential for substantial profits within a single trading session. Such stocks can experience rapid price swings, presenting ample opportunities for traders to enter and exit positions profitably. These fluctuations, while riskier, align with the day trader's goal of capitalizing on short-term price movements.

• Liquidity
  Liquidity pertains to a stock's ease of buying or selling without causing significant price disruptions. Day traders prefer highly liquid stocks because they facilitate swift trade execution. Such stocks boast a robust market presence, ensuring that there are ample buyers and sellers at any given moment. Higher liquidity minimizes the risk of price slippage and allows day traders to swiftly enter or exit positions, a crucial advantage in the fast-paced world of day trading.

Judge the stocks you have shortlisted based on their volatility and liquidity features and evaluate which stocks are relatively more appropriate for day trading as per your strategy.

Step 4 – Employ technical analysis

Technical analysis plays a pivotal role in guiding day traders towards well-informed trading decisions. Within this analytical approach lie key elements that carry particular significance in the world of day trading, including:

• Candlestick patterns
  Candlestick patterns are visual representations of price movements on charts. Recognizing common patterns such as doji, hammer, and engulfing patterns can offer valuable insights into potential price reversals. These patterns serve as a window into market sentiment, providing day traders with a distinct advantage in predicting short-term price shifts.

• Support and resistance (S&R) levels
  S&R levels are fundamental markers on a stock's chart. Support functions as a price floor, while resistance acts as a price ceiling. Identifying these levels empowers day traders to strategically plan their entry and exit points. When prices approach support, it may signal a potential buying opportunity, while resistance levels could indicate an optimal time to consider selling.

• Technical indicators
  Indicators such as Moving Averages and Relative Strength Index (RSI) (among others) provide quantitative data to validate trading signals. Moving Averages facilitate trend identification by smoothing out price data, whereas RSI gauges the speed and change of price movements, aiding in the identification of overbought or oversold conditions.

The idea is to technically evaluate your chosen stocks to identify key levels, including support and resistance as well as entry and exit points.

Step 5 – Trade as per your plan

Once the key levels have been identified, the final step is to trade as per your plan. Make sure to not give in to emotions and maintain discipline in your trading activities. After completing a trade in your chosen stock, analyze thoroughly on what worked and what did not. Learn from your shortcomings and continuously refine your stock selection strategy.

Are stock screens useful for day trading?

According to experts, leveraging stock screeners to one’s advantage can turn out to be highly beneficial. These tools allow you to efficiently filter and identify potential trading candidates based on specific criteria such as price, volume, and technical indicators. They streamline the process of finding stocks that align with your trading strategy. Moreover, stock screeners can be configured to match one’s manual screen methods, often saving a lot for time for in-depth research and analysis.

Is volume of a stock important for day trading?

Trade Volume is a crucial aspect of day trading and understanding it can turn out to be a game-changer. Here are two key methods to evaluate trade volume effectively:

• Trade Volume Index (TVI)
  The Trade Volume Index (TVI) is a valuable tool for gauging the flow of money in and out of a stock. When you observe a spike in volume, it indicates heightened interest in the stock and the potential for significant price movements. Monitoring TVI can help you stay ahead of the curve.

• Intraday Volume Analysis
  Analyzing intraday volume patterns is another essential technique. By studying how volume changes throughout the trading day, you can identify optimal entry and exit points. These fluctuations in volume provide valuable insights into market sentiment and present trading opportunities. Being attuned to intraday volume is a key aspect of successful day trading.

Is fair value of a stock important for day trading?

While fair value determination isn’t compulsory for day trading, experts suggest doing so to avoid unexpected value corrections resulting in failure of trade of set-ups. Given that assessing the fair value of any stock can be a long and tedious process. experts have highlighted some quick methods often employed by seasoned traders that can give considerable overview of a stock’s value position:

• Price to Earnings (P/E) Ratio
  The Price to Earnings ratio compares current price of a stock to its earnings per share (EPS) over the past year. A low P/E ratio compared to a company's historic average can suggest that the stock is trading at a good value. However, it's essential to consider a company's growth prospects; a higher P/E may be justified if future earnings are expected to rise significantly.

• Price to Sales (P/S) Ratio
  Ideal for growth stocks with erratic earnings, the P/S ratio relates a stock's price to its revenue per share. Historical averages provide a reference point, but it's vital to account for future revenue expectations. Notably, not all sales are equally profitable, so assess the profitability of revenue sources.

Apart from these two methods, there are also other methods such as the Discounted Cash Flow (DCF) analysis and the Dividend Yield analysis. However, these are more time consuming and better suited for long term stock-picking rather than day trading stock selection.

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