Day trading comes in many flavors, with each as unique as the individual. A few broad categories exist to choose from, or even a combination.
Some people see day trading to make quick riches. Others view it with extreme skepticism. Plenty of people try their hand at day trading only to be blown out within a matter of months (90% within six months). Many traders make a living day trading. So why do the rest of us fail?
Before you start your adventure, you need to explore the types of day trading. You can educate yourself for years, only to stumble upon a new method after a decade. At least, familiarize yourself with the methods below. If one piques your interest, you can explore it further.
Order Flow (Price Ladder)
Average number of trades per day: 50+
Common Markets: Futures
Typical Trader: Proprietary (prop) firms, experienced floor traders
Description: Order flow and ladder trading may not always be the same thing. However, we will refer to them the same way for this discussion. Order flow trading looks at the way orders trade in the market along with order book (market depth). Ladder traders look at the number of orders that exist at any price level. They consider how orders fill along with the amount filled.
You trade against other players, where the goal is to profit off others decisions. It’s like how poker players make their decisions based on what another player does.
Downside: Limited markets work with order flow. Additionally, very few platforms support ladder trading. They also typically cost a decent amount of money. Furthermore, it’s difficult if not impossible, to backtest strategies. If you look to learn more about it, little information exists.
Example: Trader A keeps buying long positions in the Soybean futures market. Trader B keeps shorting those same futures. Trader A keeps driving up the price until Trader B is forced to cover their short positions. Trader A then sells their long positions to Trader B as they cover their shorts.
Chart Analysis
Average number of trades per day: 1-20
Common Markets: All markets
Typical Trader: Retail and institutional traders
Description: Chart analysis studies price action to predict future movements. Analysts look at areas of support and resistance. They review multiple time frames and patterns. These are combined general market context to frame trades. Chartists believe that the patterns and behaviors work regardless of the instrument or time frame. This characteristic makes chart trading adaptable to various markets and conditions. Chart analysis can sit on its own, or work in conjunction with fundamental analysis.
Wall Street and traders respect chart analysis enough that you can obtain accreditation as a Chartered Market Technician. These accreditations have been around for over 50 years.
Downside: Charts themselves often lack context. Most trading patterns only work in conjunction with broader, qualitative market analysis.
Example: A day trader looks at stock ABC, which appears to be extremely bullish on daily and weekly charts. During the trading day, the stock moves lower into a support level. The day trader looks for a reversal pattern and enters the trade long. With the larger momentum of the stock, the trade captures a reversal to the upside.
High-Frequency Trading
Average number of trades per day: 1000+
Common Markets: Stocks
Typical Trader: Exclusive firms such as Citadel, Tradebot, and others with deep pockets and often set up co-located near the exchanges.
Description: High-frequency trading looks to capitalize on discrepancies between everything from tracking ETFs to exchanges. They trade extremely large volumes and capture very small movements. Sometimes these are fractions of pennies. Most of these firms employ extremely complex algorithms to analyze markets quickly.
These firms will position themselves as close as possible to exchange to reduce latency (time between order entry and when it hits the exchange). Companies will spend large amounts of capital on maintaining a technological or timing edge. A firm’s advantage may only be milliseconds at a time.
Critiques of these firms say that algorithms in charge can move markets for no reason. Many blame these firms for the previous flash crashes in the markets. However, the firms argue they provide liquidity to the market. They also claim to reduce the cost of trading by tightening spreads.
Downside: If you could afford to do it you probably wouldn’t be reading this article
Example: Firm A sees that the ARCA exchange has 600 shares of stock ABC for sale at $40.00, and 400 shares for sale at $40.01. They also see that an order on the BATS to buy 1,000 shares at $40.005. The firm will quickly buy all 600 shares and 400 shares. They sell them to the BATS buyer. They profit off the difference of 100 shares they bought at $40.00. Total profit – $0.50.
Indicator Trading
Average number of trades per day: 1-100
Common Markets: All markets
Typical Trader: Retail and institutional traders
Description: Similar to chart trading, indicator trading looks to predict future movement based on previous price action. Indicators come in two broad categories: leading and lagging. Leading indicators include oscillators, RSI, etc. They attempt to predict reversals based on extremes. Lagging indicators include moving averages and Bollinger Bands. These describe what price action looked like in the past up until the present. Their signals come after a reversal occurred.
The indicators further breakdown into four categories:
- Trend – Measures the strength and direction of a price movement compared to some baseline.
- Examples: Moving averages, MACD, Parabolic SAR
- Momentum – Identify the speed of price movement price to previous prices
- Examples: Stochastic Oscillator, Relative Strength Index, Williams % R Oscillator
- Volatility – Shows the rate of price movement change in any direction
- Examples: Average True Range, Standard Deviation, IV Rank
- Volume – Presents how strong a trend is based on volume
- Examples: On balance volume, Accumulation Distribution Oscillator, Chaikin Oscillator
It’s worth noting that some tools exist that don’t neatly fall in any of these categories, such as Fibonacci retracements and extensions.
Downside: Tons of indicators exist. Indicators alone generally won’t give you a profitable strategy. Like chart analysis, indicator trading requires additional context to become effective.
Example: Trader A buys every time a stock gets to the 20-period moving average. They sell when it gets to the 50-period moving average.
Which Works Best
You’ll find proponents of all these styles if you look hard enough.
Chart and indicator trading aren’t mutually exclusive. Many traders often combine these to create effective day trading strategies. Larger funds supplement their investment research to find the best prices and times to enter investments.
We advocate for these approaches above the others. Most traders can start and work with these approaches with limited funds. Both allow you to develop and test the strategy that works best for you. Tons of literature exists on these subjects – so much that sifting through it can be difficult.