When I was a young trainee just beginning to learn how to trade, my trainer repeatedly told me that «you’re only as good as the stocks you trade.» As anyone who has been trading for long enough can tell you, certain stocks are easier to make money in than other stocks. A significant part of becoming a consistently profitable day trader is finding and trading the best stocks while avoiding the worst stocks.
The Characteristics Of A Great Day Trading Stock
A great day trading stock has certain fundamental characteristics. I’m going to list them in declining order, with the first criterion being what I consider to be the most important and decreasing from there. Keep in mind that these are just general guidelines and are not rules written in stone.
The most important characteristic of a great day trading stock is that it has to have sufficient volume. A stock without sufficient volume makes it difficult to establish meaningful positions without affecting the price of the stock. Thinly traded stocks make it challenging to control risk as their spreads (the difference between the bid price and the ask price) are wider and it can be difficult to anticipate where you’ll be able to exit your position if your trade goes against you.
The best way to determine a stock’s typical volume is to simply look at the average daily trading volume over the last 10 days or so. Stocks with higher daily trading volumes are more liquid than stocks with lower daily trading volumes, and this difference is reflected in the average spread of a stock. The exception to this rule is when a company is «in play» as the result of a news item (such as an earnings report) or some other catalyst. When a company is «in play,» a better metric to determine its liquidity is not a trailing average daily trading volume, but rather the current day’s volume as being «in play» can dramatically change a stock’s trading characteristics.
As a general rule, great day trading stocks will trade more than 50,000 shares a day. Analyzing my own trading results, I’ve found that stocks that trade less than 50,000 shares daily are usually not worth trading as their lack of liquidity makes entering and exiting a position very difficult. Furthermore, you may have to hold a position in these thinly traded stocks for longer than you had anticipated due to their lack of volume.
A great day trading stock must not only be liquid enough to trade, but it also must give you a reason to trade it. That «reason» is simply intraday price movement. A great day trading stock must have a sufficient intraday range so that you can make money from its price movements. A very liquid stock that trades at the same price all day long will obviously not provide you any opportunities to make profitable trades in it. Contrast that with a stock that goes from $56.00 to $57.50 back down to 56.50 before shooting up to $59.00. The gyrations of this stock provides day traders with the volatility necessary to make money!
The easiest way to determine whether a stock has sufficient intraday movement is to look at the stock’s average trading range over the last 10 days or so. Larger average trading ranges are better as they show that a stock will have enough intraday movement to trade. However, the same exception that applied above to the volume characteristic applies here as well: a stock that usually has a small daily price range can explode with volatility if it becomes «in play.» These stocks typically have increased ranges as well as increased trading volume as traders weigh in on the impact of an earnings report or a takeover rumor.
The final characteristic of a great day trading stock isn’t a necessity, but should instead be viewed as a bonus. A stock that is the subject of a significant news item is often a great day trading stock on the day that the news is released. Examples of news items that could affect the price of a stock include earnings reports, upgrades and downgrades by analysts covering the stock, takeover rumors, fraud allegations (seen recently with many Chinese reverse-merger companies), drug trial news for biotech companies, same-store-sales numbers for retail companies, and the list goes on.
Stocks that are in the news typically experience increased volume and volatility as well as «cleaner» moves. A «clean» move in a stock is a stock trending to the upside or the downside with little noise in the form of retracements or shakeouts. As a day trader, it’s always easier (and less stressful!) to be in stocks that are moving cleanly as opposed to stocks behaving erratically.
Putting It All Together: The Ideal Day Trading Stock
The ideal day trading stock is a volatile stock with fresh news and tons of volume. The stock will exhibit clean moves with identifiable buyers and sellers in the level 2 box, and will allow a talented day trader to take advantage of its multiple moves throughout the trading day. Focusing on stocks that exhibit the holy trinity of volume, volatility, and news will dramatically improve your trading results while helping you to avoid the «trap» stocks that only inexperienced day traders focus on.