Trend following and the profitability of Day Trading

What happens when you day trade a bullish trending stock?

Well, it is assumed that doing day trading we may take advantage of the fabulous trends that we can find in the stock markets. At least, this is what many day trading gurus say. T

here are people who say that you should look for the hottest stocks to do day trading and that you should not do day trading with boring stocks or those that have not liquidity.

The problem with stocks day trading, or actually any other asset, is that we are going to have a lot of problems to be net winners after a bull market even if we choose the right direction of the main trend for a period of time.

Costs of day trading

There are a lot of costs involved in day trading.

We are going to see a little example of a hot stock, Apple. And how difficult is to win doing day trading even though we betted for the winning side during a period of one month in bull market.

At the same time, we will see a very simple example of swing trading for that same stock with a very different result.

Apple has multiplied itself by a factor of 300 the last 20 years.

As it is usual for this stock the last two decades we have had it trading at a maximum price recently, where the stock has crushed the maximum record of 2012 of about 100 $. It has done so after a some attempts and a the formation of a congestion area around that price, with resistance at 103 and support at 97. After some weeks doing this and having formed a channel, we could try a swing strategy for the next time the price touch the upper level at 103 and going long there.

We could set a 3% stop loss and a 15% win. If we had done that trade at the end of October (2014), we could have had a winning trade some weeks later.

A nice trade using trend following.

If we had tried to do day trading for that period, we should have expected a good profit as long as we traded the long side.

Day trading costs

As the swing trade example, we decide to be long at 103 the day the price touches that level at the end of October. The strategy is simple; we will be long every day at a higher price, trying to catch the expected bull market in Apple.

The stop we would use is 1%, and we would close the trade at the closing price. After some weeks of trading, we would have had 6,5 losing trades and 12 winning ones with an accumulated profit of approximately 10,9%. Our net profit would be 4,3% (10,9 – 6,5*1).

But this is not all, because we have to remember that doing day trading we pay more commissions and have a lot of slippage, And believe me, it will cost you some extra money.

We would have done more or less 40 buys and sells (we count some days when the price almost not moved). If we assume a 10$ commission we would have paid 400$, or, in other words, a 4% of our account (assuming it was a 10.000 $ account).

In these terms, and having the slippage into account we may conclude that we would not have had a profit doing day trading, and maybe we could have had a net loss.

But, how is that possible if we traded the long side in a bull market of almost 20% in just one month?

That is possible because day trading has many transaction costs like commissions, slippage, and the spread, and it is very difficult to win in the long run like that.

If we add another factor like the gaps, we may see how we lose some of the bull move because we enter and exit every day. And that is because, in a bull market, the gaps are usually in favor of the trend.

We can see that if we look close to the chart.

There are many days when the price opens higher than the last close, and some of those are even a loss at the end of the day.

Day Trading Stocks

Day traders want to avoid after hour’s risks but by doing so they let go an important part of a trending market. Looking at the chart, we can see little gaps of about 0.2 and 0.5 many days, which could amount for 5% of the total bullish move.

Day trading gap up

This problem of gaps happens in all sorts of assets, not only in stocks.

In forex, for instance, many people try to day trade some currencies like the EurYen, not realizing that when there is a big market swing, (like the one recently) a significant part of the move occurs overnight.

If they try to be in and out every day, they will miss some of the best moves of that swing. That is why forex traders should concentrate more in doing a sort of “week trading” and forget about day trading.

As we have seen the day trading strategy for Apple has been very bad.

However, the swing trading one has shown us a nice profit, and we did not need to spend a fortune in commissions (20$ compared to 400).

Day trading is definitely not effective when you want to trade the trend.

 

Related Post