It’s Not Your Father’s Day-Trading Anymore

My father was a day-trader back in the 1960’s and 1970’s.  He was a member of the New York Stock Exchange and traded for his own account.  He worked on the floor of the exchange, knew all of the specialists (those rich guys who were obligated to make a market when no else wanted to) and he had a sense, borne of years of trading and participating in the chatter going on around him, where the market in any given stock was likely to go. Back then, stocks were traded in eighth’s of a dollar (12.5 cents) and a big day was a few million shares on the Big Board (the NYSE).  He got out when stocks started being traded by the penny and algorithmic trading came in.  He knew he couldn’t compete.

Fast forward to today.  Like all of you, I’m a data-driven investor and each of us has more computational power in our laptops than existed in the entire world when my father was active.  Notwithstanding that advance, I often feel that our retail day-trader friends are ever more like my father than the high-frequency traders against whom they trade.  The deck is stacked in the latter’s favor and they can make millions on trades where the gain is measured in fractions of a penny per share.  But, we can take that computational power and put it to our own use – even in the current environment.

At ThinkingLonger, we have devised long-term strategies for investing and short-term strategies for day-trading by observing trends going back to 1984 (for investing) and to 1994 (for day-trading).  Without wasting your time here to explain these strategies, let’s assume that our day-trading strategy includes identifying stocks that have been extremely volatile over short periods of time (generally the previous 60 to 90 days) as candidates for day-trading in the upcoming thirty day period.

If you assumed that one of the causes of such volatility is the announcement of better than expected earnings or dividends, you would be right to do so.  If you further assumed that our analysis took such price increases into account, you would be wrong.  In fact, we ignore such spikes in predicting what stocks are candidates for day-trading.  Why?  Because, in the aggregate, our research suggests that such spikes are of such short duration that they don’t affect the price trend of our day-trading candidates over the preceding 60-90 days and it is these trending stocks that we recommend for day-trading.

Remember, on any given day, at any given moment, the short-term retail trader is playing against the high-frequency traders who are moving millions of shares backed by hundreds of millions of dollars of capital.  Absent a Reddit-like force moving a particular stock (think GameStop), the retail day-trader can’t buy faster, will never be stronger, and will never be informed sooner than our HFT brethren.  We will always be behind the curve.

Now,  we’re not saying that adroit day-traders traders can’t make a buck in a volatile market that is being moved by a better than expected news.  Some do (we suppose) and we hope that you are one of them.  If you play in this arena, we wish you northing but the best.

That being said,  we have to take the one resource we have – computational power – and put it to our advantage (or at least get closer to a level playing field).  We prefer (and our data supports the idea) that purchasing a bundle of stocks that are trending up produces good day-trading results without purchasing individual stocks that are rising at any given moment in time based on news announcements. As a result, we think the maxim “Don’t chase the market” is incomplete. Rather, the maxim should be “Don’t chase the market in particular stocks.” Our approach is to identify the stocks going up (substantially!) and buy all of them with stop loss orders to prevent anything other than very small losses in any of them.  To be specific, we recommend stop loss levels at 1/10 of one percent of a purchase price. (Unlike my father’s era, this is now possible when stocks trade up and down for a penny.)

This last point deserves a bit more discussion.  We recommend extremely tight stop loss limits because we are not willing to lose money.  We would rather have money be pulled out of the market today so that we can live to trade with those dollars tomorrow.  As day-traders, we have to live by Warren Buffett’s Rule #1 (Don’t lose money!) and Rule #2 (Don’t forget Rule #1!).  We are in the business of trading and money is our key item of inventory.  Do stocks recover after incurring such small losses?  Of course they do!  Couldn’t we have made money if we were willing to hold the stocks until they recovered and then advanced beyond our purchase price?   Again, yes, we could have recommended that.  But we don’t.  We are quite content to end up owning only the ones that go up – no matter how few in number they end up being.  Putting it another way, we are not interested in trading per se; we get no psychic benefit from the “action.”  We are only interested in making money and keeping our losses as close to zero as possible because dollar losses today preclude our ability to participate in the market tomorrow.

So, is there any usefulness to be found in price spikes based on good news?  We know that Mr. Market is crazy and his exuberance can take a stock higher than it deserves.  Good news is a signal to the day-trader that already owns the stock to raise his or her stop loss levels as we don’t (and can’t) know when the “ride” from good news will fade.  It’s just not predictable.

At ThinkingLonger, we recommend to our day-trading friends that they think in the aggregate, seeking out bundles of stocks that have recently gone up and taking miniscule losses whenever they occur. We recognize that we are recommending a very different approach to day-trading, one that abandons the imagery of the Wild West, the gunslinger and the rugged individualist.  We want data working for us.  It’s less romantic but we’d rather be Ty Cobb because so very few of us can be Hank Aaron.

FYI, here were our day-trader recommendations for the month of July 2021.  We will let you know how our July recommendations turn out next month.