Scalping is a trading strategy whose goal is to make a profit from small changes in price. Those who use this strategy typically place as many as 100 or more trades in a given day. Scalping takes advantage of a combination of large position size and small price gains in the shortest market timeframes. The goal is to either buy or sell a number of shares at either the bid or ask price and then sell once the price has only moved a few cents.
Scalping is a fast-paced type of trade that nimble traders will excel in. The ideal margin for this type of trading is 4 to 1 in order to make the most profit in the shortest amount of time. Typically, scalpers focus on either the 1-minute or 5-minute candlestick charts. Commonly used indicators include the MACD, RSI and stochastic. Price chart indicators like pivot points and Bollinger bands are often used to determine levels of resistance and support. It is recommended that you have at least $25,000 worth of trading capital in order to utilize this strategy successfully.
Common mistakes to this strategy include choosing poor execution times, not setting the correct stop losses, late exits, late entries and overtrading. Scalping creates a high amount of commissions which means you are going to want to look for a per-share commission price structure for the best results.
A fade is an investment strategy based around taking a contrarian approach to the current trend. This is a high-risk strategy that has the potential for high short-term gains when it works out in your favor. The reasoning behind this is that once the initial surge or spike in price has occurred then the resulting retracement or pullback will be able to generate a profit. To know you are on the right path when it comes to one of these strategies, you will want to look for a gap between the price and the trend line, this means the price is heading more in the direction of the trend and away from the trend line.
The right time to fade a breakout is when you have reason to believe that the breakout from either the resistance or support level is false which means it is unlikely to continue for much longer. You would then want to put this strategy into play when you have reason to believe that this breakout is going to be substantial.
Most fade breakout trades tend to fail because the minority who chose to fade the breakout is frequently compromised by the major players in the market who want the current trend to continue. Remember, in order to sell something, you need to have a buyer and if everyone is currently buying above the resistance level or selling below the support level then the number of buyers for what you are proposing is going to be relatively slim. There is a reason that this is a high-risk strategy.
In momentum trading, traders tend to focus on stocks that are currently moving in one direction a significant amount. Those who trade based on momentum typically only hold their positions for a few minutes at a time, though it can be longer depending on the speed at which the stock is moving.
Successful momentum trading requires the trader to analyze the list of stocks they favor by watching the charts, particular the momentum indicator which visualizes the total net change of a stock’s closing price over a predetermined period of time. The momentum line is typically show in tandem to the price line and it shows a zero axis with positive numbers indicating an upward trend and vice versa. This indicator will typically determine an incoming breakout which means that even 2 periods of sustained momentum will be enough to cause a breakout.
Once a potential momentum trade is found, you don’t need to jump on it right away as this type of trend is typically likely to continue for more than a few periods. It is important to keep an eye on the stock in question once you have made a move, however, as the second the trend seems to be dying out you need to sell to keep from losing a slice of your profits. The goal here is to find the saturation point which is where the number of orders starts to increase and the overall volume of bidding begins to slow. This point doesn’t mean the momentum is stopping, it is just a good indicator that it is slowing down.
When it comes to trading options many day traders remain perfectly content with simple puts and calls when it comes to making money from market indecision or possibly using covered calls as a means of generating income. There are more promising alternatives available, however, and one of these is the butterfly spread. This strategy allows traders in the know to pinpoint the traders that are likely to generate the greatest amount of profit for the lowest amount of risk. The modified butterfly spread, also discussed below, takes things up a notch.
Standard butterfly spread: The perform the standard butterfly spread you are going to want to utilize 3 different puts or calls in a 1, 2, 1 configuration. The first call you place is purchased at a strike price that is similar to the current price of the underlying asset, the second pair is purchased at an increased price and the final call is purchased at an even higher price. The same strategy can be used for puts though the price descends rather than ascends.
What you end up with is a neutral trade that is sure to generate a profit assuming the underlying asset remains somewhere in the range of the strike prices. It is also useful if you are interested in profiting from a directional trend as long as you set all three either below or above the current strike price depending on if you are purchasing puts or calls. Assuming it is done correctly, this strategy minimizes risk to a defined level and offers a reasonably reliable potential for profit and the potential for a significant rate of return as well.
Modified butterfly spread: The more advanced form of this strategy is called the modified butterfly spread and it has similar goals to the standard version, though it differs in a few key ways when it comes to execution. The biggest difference is that it offers you the opportunity to maximize your profit if put trades are bullish and call trades are bearish. This is done via a ratio of 1, 3, 2 which leaves just the first put or call at the breakeven point and triples up on the higher/lower price and doubles up on the final price point.
For example, say that an underlying asset is currently being sold for $194 per share. To activate the modified butterfly, you are going to want to activate the first put at $193.50, three more at $190 and then the final pair at $175. The key takeaway from this example is that puts are selling at 5 points beneath the at-the-money point and another at 20 points below. As the price is currently at $194 this means that you will be able to breakeven if the price drops to $184 which means that the strategy generates 5 percent worth of downside protection.
This means that the underlying asset in question would need to drop a total of more than 5 percent before any type of loss would occur. In this example, the total potential loss is approximately $2,000 which equals the amount required to put the trade into action. In this case, the loss would not occur until the underlying asset dropped to a price that is lower than $175. On the other hand, the amount you stand to gain from the aforementioned trade equates to about $1,000 which is a 50 percent return on your investment assuming the underlying asset only increases to $200. The strategy would also result in a $500 profit as long as the underlying asset doesn’t move past $195.
While the modified variation of the butterfly spread contains a greater degree of risk than the standard version, it also offers a higher profit to risk ratio. It is most useful when you believe the underlying asset is likely to remain stable over the timeframe you have chosen or when you are looking to profit from capital gains on an underlying asset that is likely to remain in the middle of the road.
Criteria to consider
When it comes to determining the correct type of butterfly spread to use it is important to keep in mind the amount of money you are willing to lose based on your total trade capital. You will also need to determine the estimated risk based on the current state of the market which will determine your overall odds of failure or success. There is no one right answer to this question, you will need to ask yourself these questions and set your own limits to determine the type of butterfly spread that works best for you.
The potential for the return on your investment, along with the likelihood that you will actually see it are going to determine the level of risk that it is in your best interest to proceed with. Performing this risk/reward analysis is crucial as you want to avoid rushing into the modified butterfly spread simply to mix things up or to try something new. It should go without saying that it is only recommended that you use the modified version if you have a sizeable amount of trade capital stashed away.
When it comes to day trading options, it is a great choice for day traders looking to improve the flexibility of their trades while mollify the risk/reward ratio of an existing underlying stock that is not as strong as you would otherwise prefer. As long as it is only used when required, and the conditions are right, the modified butterfly spread adds to that flexibility even more.