<s> The Wizetraders’Guideto EffectiveDay TradingMel Raiman, Ph.D.
Copyright © 2003 by Melvyn L. RaimanALL RIGHTS RESERVEDThis publication may be reproduced or trasmitted by e-mail for personal use.Permission for commercial use must be requested from the copyright holder.The information and suggestions expressed in this publication are the personal opionions of Melvyn L. Raimanand have not been endorsed by the manfufacturer of Wizetrade and WizeFinder. This information is beingprovided to users of Wizetrade at their request for their personal use and Melvyn L. Raiman assumes no responsibility for their trading results. Since there are many vairables inherent in day trading including the skill level ofthe individual trader, his or her ability to interpret Wizetrade charts, the direction of the market, the execution ofthe trader’s broker, and the trading characteristics of a particular stock, it must be assumed that there will be arange of success rates when applying any trading system.
ForewordI had the pleasure of speaking about day trading at WizeFEST 2002. Afterthe convention I prepared a small document addressing the subject of proxyWizemen and have since received numerous phone calls and e-mails.First of all, there is obviously considerable interest in day trading. Secondly, based upon the questions that I am asked over and over, traderswant very specific answers to a multitude of questions. The purpose of thisexpanded publication is to answer many of these questions which I receivedaily. It’s really a short course in day trading with Wizetrade, and it is mysincere desire to bring everyone up to speed in the art of day trading. Yes,day trading is an art. There is a sixth sense, or a rhythm to day trading.Those who have it do better than those who do not, but everyone whoapplies the principles outlined in the next few pages has to potential forconsistent success in this endeavor.There is another reason for writing this publication. Since Wizefest, Icontinually hear references to Mel’s Method. What I have been recommending is not a trading method, but alternative chart settings. You willdiscover, after looking through this material, that I use many trading methods or systems. Day trading need not be a haphazard, frantic occupationand, maybe together, we can take some of the mystery out of short-termtrading.Some of you are already master Wizetraders and are hauling in thousands of dollars everyday. You probably know most of the following information and have mastered the techniques needed to execute your favoritetrading strategies. If that is the case, just reach over and press the deletekey on your computer. I know that I have learned a lot compiling this information, which has forced me to rethink the whole trading process and,gain new perspectives in regard to the day-trading profession. I believethat everyone will gain new insights into trading after reading this e-book.In fact, there is information contained herein that I guarantee will be new toevery one of you.I hope to follow-up this project with an update when the situation warrants. In the meantime, I wish each of you immense success at your chosen full- or part-time profession.Mel Raiman
Table of ContentsForeword ................................................................................................................. 2Let’s Take Care of Business .................................................................................. 4Day trading Is A BusinessRecord Keeping and the IRSA Little Common Sense Can’t HurtDay Trading: Precision is the Key ........................................................................ 5Day Trading Is More Than A Time Frame .................................................... 5You Must Have Goals and a Little More about Cash Management............. 5The Importance of Fundamentals to Day Traders ....................................... 6The Importance of Technical Analysis ......................................................... 6Long Versus Short ........................................................................................ 7Market Versus Limit Orders; Getting In and Out of Trades ......................... 7Stocks Have Individual Trading Characteristics .......................................... 8Setting the Lights ................................................................................................... 9The Problem of Using a Swing-Trade Setup for Day Trades ...................... 9The Rationale for using Proxies for the Three Wizemen .......................... 10Defining the Day-Trading Setup ................................................................ 10Using the Charts to Manage A Trade ................................................................... 11Managing and Exiting A Trade ................................................................... 12Setting Stops .............................................................................................. 13Forcing A Trade .......................................................................................... 13The Most Important Factor in Finding A Trade ................................................. 13Tools of the Trade: Finding A Trade ................................................................... 14Tools of the Trade Part II: Find a Trade in Real Time ....................................... 15Day-Trading Strategies ......................................................................................... 19Charlene’s Method and Finding Stocks That Will Gap at the Open .......... 19Jack’s System ............................................................................................ 19Rockets ...................................................................................................... 20Rocket Theory With A Twist ....................................................................... 21Finding Trades With A Little Homework .................................................... 21Fail Safe Method ........................................................................................ 22Optional Method ........................................................................................ 22Notes on Scalping ...................................................................................... 22Trading On The Five-Minute Trend: Faster ............................................... 23West Coast Offense ................................................................................... 24Shorting Tips .............................................................................................. 24The Heatmap Strategy ............................................................................... 25Breakouts and Breakdowns ....................................................................... 26Follow-up or Secondary Runs .................................................................... 26Stalking and Variations on Stalking ............................................................ 27Rallies, Reversals and Dead-Cat Bounces ................................................ 28Some Final Thoughts About Day Trading .......................................................... 30
1: Let’s Take Care of BusinessDay Trading is a BusinessThis first chapter is where we take care of some business before getting to the good stuff. I’m awarethat some readers are new to Wizetrade as well as new to day trading. So here we go: trading on-line isfun, it’s just like a computer game with one major difference, there is a lot of money at stake. So, unlessyou have money to burn, you had better approach day trading as business. I realize that many readerswant to get to important subjects such as which light should be used to exit a trade, but if you have neverrun your own business, you need to hear it.
Record Keeping and the IRSInvesting is not a business according to the IRS. If you are an investor, holding stocks for years at atime (buy and hope), then you are required to pay capital gains. Trading, however, is a business and thepeople who work in the field are called traders. If trading is your full-time occupation, you should beregistered with the IRS as a “Market to Market Trader.” As a registered trader, your income is simplyordinary income and you have a wide range of allowable business deductions. Also, the filing process isactually far easier. I found the forms on the IRS web site, printed them out (search for market to market),and attached them to my tax return; it’s just that simple to register.Secondly, you need records, unless you enjoy audits. At the market close, every day, I fill in mytrades on Microsoft Excel. When tax time rolls around, I print out all of the trades and attach them to myreturn. Why audit me? I’ve already supplied all of the information. If you supply the brokers statements,you may have a problem since they are not formatted a s round trips, that is complete trades. I wrote twoformulas, one for longs and one for shorts, and simply fill in the boxes every day. It takes just a fewminutes, but my records are ready at tax time.Type
Stock Share Price
Date
Fee
Date
SHORTLONGSHORTSHORTSHORTSHORTLONG
NTAPOPWVNTAPGDTMRLNETANETA
07/10/0107/11/0107/11/0107/11/0107/11/0107/11/0107/11/01
$7.00$7.00$7.00$12.00$12.00$17.00$14.00
07/10/0107/11/0107/11/0107/11/0107/11/0107/12/0107/12/01
2000200020002000200020002000
$11.21$21.21$10.46$29.81$16.21$10.36$10.71
Shares Price Fee2000200020002000200020002000
$10.80$21.40$10.41$29.40$16.10$10.36$10.95
$7.75$8.43$7.71$8.99$8.09$7.11$17.00
P/L$834.75$364.57$114.71$840.99$240.09$24.11$449.00
A Little Common Sense Can’t HurtI’ll leave cash management to other sections of the publication and other people’s books. You do,however, need a modicum of common sense, perhaps a touch of fear. A few weeks ago I trained a newWizetrade user. She called me a few days later and thanked me for recommending a stock. It turns outshe made $2,200 trading 10,000 shares of a $2 stock. There is not doubt that the potential for profit isgreater, the more shares you hold, but so is the risk. Personally, I hate to paper trade. If I’m trying a newtrading method, I’ll trade 100 shares, that makes it real money. If it goes against me a dime, I lost $10, not$100. On the other hand, I generally don’t exceed 1000 shares on any trade, perhaps I’m just a coward, butI’ve had too many trades go against me over the years. I can’t stand the pain, but I can stand a little whilea stock does a brief retracement (and Aussie Rob says stocks are boring). So, if you are new to trading, ornew to Wizetrade, make your first real trades with just a small amount of shares. This will keep you out oftrouble. I believe that all of the experienced Wizetraders have already discovered that Wizetrade is notthat easy; Wizetraders must make a lot of decisions and maintain a mental image of eight charts plus a lotof other information. I should mention, however, that Wizetrade is the finest trading platform bar none.The information the trader receives cannot be matched by any other trading system.
2: Day TradingPrecision is the KeyDay Trading is More Than A Time FrameI assume that you are either already a day trader or are considering day trading if you are reading thise-book. Day trading is unlike other trading methods where the various time frames often define tradingstyles. For example, position traders often hold stocks for months, intermediate traders for weeks, andswing traders for days. Day traders, however, cannot be characterized as holding stocks for one day. Thereare instances calling for a trade that lasts just a few minutes, or perhaps a few hours. I have had profitabletrades last just seconds. I think you get the idea; day trading is a catchall term that encompasses manydifferent trading strategies which take place within a one-day trading period. There will be instances inwhich what began as a day trade develops into a swing trade, and other possibilities for overnight holds,but in general, this publication addresses day trading strategies.As you read about the multitude of strategies and tactics that day traders use, (you can’t use themall), it will be your decision to adopt those, or the one, that best fits your temperament. Many day-tradingstrategies are presented in detail which include chart settings, chart interpretation, execution of the trades,and most importantly, how a trader finds trades, or the best stocks to trade for a particular strategy. Newstrategies appear all the time, so please let me know if you have something you would like to have addedto the next version of this publication.Traders who are most successful are specialists who use just one or two trading techniques andbecome experts in their execution. Focusing on one or two strategies will bring repeated success. Everytime someone brings out a new strategy, we run to it, hoping for the magic bullet. Well, I have not foundany magic bullets, but I have identified a number of tactics that bring repeated success. Knowing how toexecute a particular strategy and being able to find the stocks that are ready to move when you want totrade is the most difficult situation facing most day traders. The bulk of the messages that clutter messageboards has to do with finding or identifying trades. At various times I have traded in a network of tradingbuddies using instant messaging. I heard over and over: “have you got a trade,” or “I need a trade.” Thegood news is there are now some highly effective techniques for identifying stocks that are ready totrade—whenever you need a trade. I think you will enjoy and profit from these new developments in findingstocks that are about to, or have just begun to rally , long or short.There are numerous advantages to day trading as well as disadvantages. Because day traders makemore trades than, say, position traders, there are more opportunities for error. Another disadvantage is thatday traders often miss the really big moves that some stocks make. Therefore, some day traders letsuccessful day trades develop into swing trades. Confirmed day traders, however, always close theirpositions before the market closes. An advantage to day trading is not holding stocks overnight. In thismarket, anything can happen which might cause stocks to gap against you at the open. I am wired as a daytrader and just hate worrying about a position when the market is closed.Finally, if you wish to day trade, you should be willing and able to sit in front of a computer all day andmonitor a trade. If you cannot, then you can trade in the intermediate or long-term time frames.
You Must Have Goals and a Little More about Cash ManagementAll trades have goals. If you have a J.O.B., then your goal may be to simply makea little extra now and then. Of course, if you have a J.O.B., then you probably shouldnot be day trading. If your goal is to earn a specific amount each day to build aretirement nest egg, pay some of your bills, or provide a regular income, you caneasily compute what you must average each day to accomplish this goal. There are240 trading days in the calendar year. If you want to earn a gross income of, forexample, $50,000 per year, then divide this sum by 240 which is $208 per day. To thisyou must add your trading costs. If your round trip is about $15 and you make an averageof one trade per day, then you must average $223 per trade. Now, use this information in your cashmanagement. Let’s say that you find a great trade and are about to put on a trade. Suppose you buy 100shares—not very many shares—then this stock must move $2.23 in order for you to achieve your goal. It
is not very realistic to expect to profit this much on your average trade (in your dreams). Parenthetically,many day traders subscribe to the 2.5% rule, that is, on average, you should not expect to get more than2.5% on a trade. That indicates that if you are trading a $30 stock, you really should not expect to get morethan 75¢ from the trade. Actually, you don’t know what you will get from the trade since there are so manyvariables. To be on the safe side, you probably should buy any where between 500 and 1,000 shares, if youhope to get your day’s pay from this trade. Either that, or plan on making more than one good trade duringthe day. Let’s complicate the matter, perhaps the ask for the stock is $75—“oh no, I can’t afford it.” Well, ifyou have a small trading pool, then you might plan to trade stocks that are lower priced. Actually, there aremany lower priced stocks that have a fairly good Average True Daily Range.Average True Range—the difference between the daily high and low price of a stockaveraged over a number of days. The price of a stock does not govern it’s range,although higher-priced stocks tend to have greater ranges. Sometimes, stocks withhuge Average True Ranges are more volatile, which is something to consider. Examples would be ABC which has a $2.45 Average True Range (and can be highlyvolatile) and ADM (Archer Daniels Midland) which is a $12 stock with a 20¢ AverageTrue Range). My on-line brokerage has a stock screener which allows me to searchfor the highest Average True Ranges within any price range. Further, I can select theBeta range, which will keep the volatility of the stocks within a pre-selected range ofvolatility. If you wish to find the Average True Range of a Stock, go to http://barchart.com, enter a stock symbol, and then click on Technicals on the left side ofthe page.
The bottom line is that you have to select stocks to trade that have the potential to generate areasonable profit while, at the same time, being in a price range that will allow you to purchase a reasonable number of shares (or sell short). Personally, I don’t thrive on extreme intra-day volatility (the traderneeds a seat belt), on the other hand, I hate watching paint dry, therefore, I tend to look for stocks that havea point or more Average True Range or find a stock that is rallying (more on that later).If all of the above seems overwhelming, we will address the whole issue of finding the best stocks totrade later in this e-book. Once you decide on how you will trade every day (your trading plan), and whatstrategies you will employ, all of the above becomes second nature through repetition. That is why it isimportant that you become a specialist. It is imperative that you have a trading plan before the open ofeach market. Just hoping to stumble across a good trade during the day, perhaps by listening to the dailyWizetrade broadcasts, is a sure fire way not to develop a steady income.
The Importance of Fundamentals to Day Traders (Don’t Send Me An Annual Report)Every trading day I try to find the stocks that are driving the market. A few days ago I found one thatwas screaming long on huge volume. When I found the stock, it was already up about two points, itfinished the day up $4.60 from the open. That’s a screamer—a WOW! (I’ll tell you later how I find thesestocks every single day.) I had never traded this stock before and the name was not familiar. I thought itwas a retail store from the name. Was I ever wrong, it turned out to be a global positioning satellitemanufacturer. No matter, it had what I needed and wanted in a day-trading stock: a huge increase inrelative volume (momentum) and was taking off. The Wizetrade charts were vertical and separated. I hadno plans to invest in the company, or attend the annual meeting. I wanted a trade. I did not now the PEG,the PE, cash flow, EBIT, dividend, etc. Furthermore, these fundamentals really did not matter to me at thetime. The only thing that mattered was that it was in the first stages of a huge rally. Parenthetically, it wasflat the next day, but that’s OK, I found a different screamer to trade. I believe you get the point, fundamentals absolutely do not matter to the day trader. Well, how about the following:
The Importance Technical AnalysisI hate to think of the hundreds of hours I devoted to learning technical analysis and the 3-4 hours Ispent every evening working on setups based on my knowledge of technicals. Now, Wizetrade is mytechnical analyst. It tells me what a stock is actually doing, in real time, in up to eight time frames. I still find
it comforting to know where support and resistance are, but beyond that, I trust in the Wizetrade charts. Anequity may have a golden cross, or make a double bottom, but all that really matters is what it is doing now.I used to subscribe to a day traders’ setup service. Every day these professional traders would present alist of stocks to trade along with the triggers (pivot points) for going long and short. I noticed that the dailysetup list always stated that if you have the “red light—green light system, just follow the lights.” I finallyfound out that they were referring to Wizetrade. In fact, these professional traders were already tradingWizetrade.
Long Versus ShortIt is helpful and profitable to be able to go both long and short. If you are new to trading you need toread this, if you are experienced, skip ahead. Going long simple means buying a stock and selling it whenit is at a higher price (buy low, sell high). Shorting allows the trader to make a profit on a stock that isdropping in price. There are traders who only go long and others who only go short. One advantage ofshorting is that when stocks drop, it is often a very quick and significant move.Let me briefly explain how a short works. First of all, you must have a margin account with yourbrokerage. A margin account allows you to borrow stock from the broker (you can also trade on credit).When you short a stock you are actually borrowing the stock from the broker, hence the margin account,even if you have the cash in the account to cover the trade. The trade begins by borrowing the stock andselling it; the term used is selling short. Since you initiated trade by selling short a borrowed stock, thecash from the sale is placed in your margin account. You are going to have to buy back this stock andreturn it to the broker; your trading goal is to buy it back at a lower price than you sold it. You get to keepthe difference. When you buy back the stock, you buy to cover. That’s about it. Reading the Wizetradecharts is the same, just upside down. There are a few other things you need to know. Sometimes your tradewill be refused because your brokerage does not have shares available to sell short. One other importantpoint, after placing your order, you must have an up tick, that is, the price of the stock must move up (apenny will do) before they will fill your order.The big boys don’t have this rule; it was instituted to keep the small trader out of thislucrative portion of the market. Why not have a down tick rule that forces the trader towait for a down tick before entering a long? I love symmetry.
Market Versus Limit Orders and Other Information About Getting In and Out of TradesAlthough we will address dealing with market makers and specialists later, at this point, keep in mindthat orders for selling short should not be at the market, but placed as a limit order. When sending a marketorder to sell short, you are giving a license to the market makers to fill you at any price (what ever themarket price is when they get around to filling your order). This is particularly risky for a short because youwon’t get filled until there is an uptick. Suppose the stock falls a point without an uptick while you arewaiting to get filled—remember, you can NOT cancel a market order—and you finally get filled at thebottom. If you had placed a limit order, the price would simply have dropped past your limit without filling.At that point, you should cancel or modify the limit (you don’t want to get filled when the stock is on the wayback up two hours later) and file a new limit at a lower price. I always set my limit just below the bid. That’sright, you sell short at the bid price, not the ask. Maybe the next paragraph will clarify buying, selling,selling short, and buying to cover.At what price do you buy and sell for longs and shorts? Aussie Rob once mentioned an easy methodfor remembering: “you always get the worst price.” When you want to go long, what to you pay, the bid orthe ask. Which is the worst price—the ask—that’s what you pay. When shorting, you want to get thehighest price. You guessed it, you sell short at the bid, or the lowest price. When you are ready to buy tocover, you want the lowest price; right again, you get the highest price, that is, the ask. You always get theworst price. Easy isn’t it?There are many instances when I place orders at the market (a market order). For example, when Iam trading a highly liquid (high volume stock) with a small spread, I usually go in and out at the market onlongs. I also use market orders to exit short positions (buy to cover). It’s just entering shorts that is particularly difficult. That is also the reason that Wizetrade recommends trading only highly liquid stocks for
shorts. If there is a lot of action, you won’t have to wait forever to get filled. The general rule is a minimumof 300,000 shares of average daily volume for longs and 600,000 minimum average daily volume forshorts. I generally look for stocks that trade a million or more shares a day.Here is another rule of thumb: for every thousand shares you plan on trading, the stock should tradea million shares a day on average. Remember, it is easy to get into a trade, but you want to be able to getout when ready to sell. Also, low volume stocks tend to have higher spreads (the difference between thebid and the ask).
Stocks Have Individual Trading CharacteristicsStocks have personalities. One advantage to trading the same stocks all the time is you learn howthey trade. I have often traded MSFT (Microsoft) and know that the spread is always 1¢ or 2¢. Recently Imade several trades on BBY (Best Buy). On BBY there might be a very tight spread, but, when thespecialist senses a rally, he or she raises the ask price a dime or so (in the NYSE trades are executed bya specialist; the NASDAQ uses a system of market makers). This is aggravating (polite language) if youare just about to enter, but great if you are already in the trade. If you are trading a stock for the first time,you often don’t know how it will move. Some stocks are incredibly volatile, others trade as smoothly as silk.These personalities actually reflect how many traders are on the stock, the personality of the market makerand other factors. The more day traders, the more volume, the more volatility. I can assure you that youwon’t have this volatility trading food stocks, but then the potential for big moves won’t be there either.I guess you have gathered that I like highly liquid stocks with an acceptable Average True Range anda small spread. When the spread is penny or two, I just go in at the market. When the spread approaches8¢ or 9¢ I am unwilling to pay the ask price. If I really want in, I split the spread, that is, I send a limit orderbetween the bid and ask and hope to get filled. Often, the stock starts to move and I don’t get filled. At thatpoint, if I really want in, I just cancel the limit and send a market order. If it starts moving too fast, I just passon the trade. Another rule: never chase a trade.Here is a situation you may have faced, or will face. Orders are being filled above the ask; you cannottrust the market maker to fill you at the ask. What you should do here is place a limit order a penny abovethe ask. The rules state that you become first in line to get filled, at the best price, which is the ask. Thisoften works but not always. I desperately wanted to get into S (Sears) and placed a limit above the ask. Iwas ignored; I waited about two or three minutes—no stock—then the stock rallied and I just passed on thetrade. I no longer trade S, it’s on my blacklist because of the personality of the specialist. He had his plansfor a rally and just ignored me.Throughout the rest of this e-book, we will address trading issues, but now it’s time to move on to thenuts and bolts; the good stuff; you know, what light do I use to exit.
3: Setting the LightsNo, You Don’t Trade the Colors, You Trade the ChartsI had a gentlemen tell me recently that he went long when all the lights were green. Wouldn’t it begreat if it were that simple? It is not and he has lost a lot of money. I used Wizetrade for quite a while beforeI realized that I really did not understand it. Keeping track of eight charts, timing entrances and exits,finding trades that are setup properly, and monitoring the market is tough. Furthermore, the longer thetrade, for example a position trade can be very long, the more room there is for slippage, the shorter thetrade, the less room for slippage. If you are a scalper trying for pennies, then your level of precision mustbe close to perfect. If you don’t want to handle these situations, then do not adopt those strategies callingfor super-high-levels of precision. I’ll illustrate several situations and how they might best be handled. Inthe process, we will establish some rules. In the end, however, your success will come down to your skilllevel at identifying trades, interpreting the lights and their relationships, and timing.“Successful trading is really very simple. Buy a stock at the right time and sell it atthe right time.”
When I first installed Wizetrade, I used a traditional light or chart setup which can be used for position, intermediate, or swing trades. This setup, which is illustrated below, employs the Three Wizemen asdirection indicators, calls for a cross on the day chart that is no more than two-days old for day trading, anda relatively new 150-minute chart.Typical Swing Trade SetupThree Wizemen(Direction of the Trade)
Timing Lights
2Min
10Min
30Min
90Min
150min
ShortTermDays
TriggerLight
TradingLight
MidTerm(Wks)
LongTerm(Mons)
The Problem of Using a Swing-Trade Setup for Day TradesLet me make it clear that if you intend to swing trade, you must use the above setup and follow therules calling for a strong month, week, and a fresh cross on the day. My experience using the above setupfor day trading has been relatively unsuccessful. I was trying to line up too many charts, that is, get toomany ducks in a row. I forever had stocks on my radar but seemed to always miss the fresh crosses.Furthermore, I kept noticing that the stocks that were rallying for the day often had unacceptable Wizemen(see chart above). Every now and then everything was in place and I had a nice trade, but not oftenenough. Throughout these early experiences with Wizetrade, I noticed that I could trust the long minutecharts in regard to the short-term direction of a stock. A fresh cross on the 150 to the upside almost alwaysmeant the stock would rally long, despite what the three Wizemen, which are long-term trend indicators,said. I can’t tell you the number of longs and shorts that I have missed because I was following the rulesand did not take trades because of the Three Wizemen. The new chart setups that I developed changedthe whole situation. As an example, I recently traded MO (Phillip Morris) long for $1.16 on a strong 150against a red day light.I trade for a living, I trade every day, and I trade in every type of market. I cannot afford to sit aroundwaiting for a trade. I can’t afford to pass up good trades just because of some long-term indicator. You getthe idea. The Three Wizemen are much longer-term indicators and take time to catch up with the shortterm trends of a cycling or channeling stock, which are the day-traders’ bread and butter. The principle oftrading with these Three Wizemen is absolutely sound and will protect the investor (not the trader), but thesystem is impractical for the day trader. The day trader must be nimble and able to change direction at alltimes, but at the same time, execute safe, low-risk trades.
The Rationale for using Proxies for the Three Wizemen (A Transfer of Power)We are now going to look at a new paradigm