As a day trader, a big part of your success will depend on your ability to quickly analyze stocks as potential trade candidates. I often trade dozens of stocks on a given day, and I can do so successfully because I’ve finely honed my stock analysis process. In this article, I’m going to give you the exact process I use to quickly analyze stocks. The things I take note of are:

1. Trend

Is the stock going up, down, or neither? I look at a stock’s trend both on an intraday basis as well as a longer-term basis.

2. Volatility

How volatile is the stock? You can just glance at a chart and get a pretty good sense of a stock’s volatility. When the stock makes a move, how long do the moves last for? Are we talking about 10 cents or multiple points?

3. Volume

How many shares has the stock traded today? How many shares does the stock typically trade? What is the current relative volume of the stock compared to its average volume (this can clue you in to institutional participation).

4. Industry/Sector

What industry/sector is the stock in? Once I find this information out, I’ll take a quick glance at the other stocks in the sector to see how they’re moving. For instance, if I type up an oil stock, I’ll take a glance at other oil stocks and the oil service holders ETF (OIH) to see what the sector as a whole is doing.

5. Relative Strength

How strong is the stock compared to the market as a whole? Does it stubbornly refuse to go down as the broad market sells off? Or perhaps it refuses to participate in a broad market rally? Or perhaps it’s following the market in lockstep. This is critical information that will determine your trading strategy with a particular stock.

6. Key Levels

Are there any important technical levels that I can identify in the stock? I’ll look at the stock’s high and low for the day as well as scan the order book for any irregularities. Perhaps there is a support or resistance level that has been tested in the past. Key levels often form the basis for excellent risk/reward trades.

7. News

If the stock is volatile or in play, I’ll take a quick glance at the news out on the stock so that I’m informed. Keep in mind that this isn’t so that I trade explicitly based off of whatever the news is, but rather just so that I know that the stock I’m focusing on reported earnings or is the subject of takeover talks. I use Google Finance and Stocktwits as my main free stocks news sources.

Simple Process, Powerful Results

While it might not look like much, what I’ve described above is my exact process that I use to rapidly filter through hundreds of stocks in a given day to find the best trading candidates. With practice, you can master it to the point where the entire process may take you 15-30 seconds. Remember that in day trading, every second counts and the difference between being early and being late is often the difference between profits and losses.

By asking these questions each time you type up a new stock, you’ll be focusing on the information that matters to your bottom line while ignoring the fluff that isn’t relevant. Thanks to the process outlined above, I can usually decide in a few seconds of looking at a stock whether it presents a potential trading opportunity. This simple 30-second process of stock analysis is a definite edge I have over other traders, and I hope you’ll take advantage of it too.

Watch this video to find out the right way to trade stocks in the news, including what you must watch out for and how to stay informed.

Find out the key technical levels in this free video analysis of SPY.

A stop order, otherwise known as a stop-loss order, is an order placed to exit a losing trade that triggers when the price reaches a certain level (there are more complicated stop orders that depend only on the order book and not the price and some require volume confirmation, but for the purpose of this article I’m going to focus on the standard stop order). A stop order is placed below the market for a long trade and above the market for a short position.

The two main types of stop orders are stop market orders and stop limit orders. A stop market order will cause you to exit your position at the market when the trigger price is hit. A stop limit order will post a bid or offer once the trigger price is hit. The downside with stop limit orders is that it’s possible for the stop to be triggered without you exiting your position – remember that with limit orders, you can set the price but aren’t guaranteed an execution. For this reason, I typically recommend stop market orders over stop limit orders in most cases.

Why Place Stops?

Stop orders are important tools to help traders minimize their losses on trades that don’t work out. Too many traders tend to hold on to losing positions for too long in hopes of a possible turnaround. Instead, traders should exit their losing positions quickly. Stop orders allow a trader to set the amount they’re willing to lose on a trade, thus ensuring consistent risk management.

Mental Stops

A mental stop operates on the same concept as a regular stop order (a trigger price causing you to exit your position), but exists only in the trader’s mind. Frequently, day traders will prefer mental stops over actual stop orders as mental stops allow for more flexibility in exiting a position. If you decide to use mental stops, the key is to maintain your discipline and resist the urge to ignore your stop (thus making the stop worthless).

Trailing Stops

A trailing stop is a stop order that moves with the price of the stock. They can automatically move (for instance, a trailing stop that is always 10 cents away) or you can manually change your stop orders to achieve the same effect. Trailing stops allow traders to both manage their risk on the downside as well as to continue to participate in a stock’s move. If you place your initial stop 10 cents below the market and the stock moves 20 cents in your favor, it only makes sense to move your stop up to protect some profits. Otherwise, your stop would now be 30 cents away!

A key point to remember is that trailing stops only move in the direction of the underlying position. A trailing stop for a long position will only move up in price, and a trailing stop for a short position will only move down in price. Otherwise, a trailing stop that kept moving down on a losing long trade would be useless.

Where To Place Stops

The skill of placing stops is more art than science, but there a few general guidelines I like to follow. First, I place my stop at a price that will confirm that my initial trade idea was incorrect. This price generally coincides with my reason for making the trade in the first place. For instance, if I’m making a support trade thinking that a stock will bounce off a key support level, then I will usually place my stop immediately below that support level.

Second, I don’t like to place my stops too far away from the market as that represents the risk I’m taking on the trade. Remember that trading is all about making good risk/reward trades, so managing your risk by setting tight but appropriate stops is critical. It can be a bit of a balancing act between placing stops that confirm your initial trade hypothesis incorrect while also making sure that the stop isn’t too far away.

Finally, consider the likelihood of other stops at a given price when setting your stops as well. For instance, stops tend to cluster at key levels and new highs or lows, so be aware that setting your stop where others have likely set their stops might lead to some significant slippage on your stop orders. Don’t assume that just because you set your stop order at a particular price, that you’ll receive that exact price back when the order executes.

Conclusion

Stops represent a key tool in a trader’s arsenal to limit downside risk. Whether you choose actual stop orders or mental stops, the important thing to remember is to never move stops further away from the market. When placing stops, consider the rationale behind your trade as well as your risk/reward ratio and the likely actions of other traders as well.

Far too many beginning traders fundamentally misunderstand what trading is all about. Brought up on soundbites from CNBC and mistakenly conflating investing with short-term trading, the novice trader thinks trading is all about the quest for certainty and conviction. The conviction to know where a stock is going, the conviction to put on large size, the conviction to hold when things go awry and you know that you’re right.

The problem with this understanding of trading is not merely that it’s incorrect, but that it’s debilitating as well. It leads to a case of analysis paralysis for the poor developing trader, frustrated that he’s never certain about any of his trades. Confused as to why he never feels certain with the trades his current method is producing, he inevitably switches methods and starts the process all over again.

You may fall prey to this problem as well. The test is simple: how long have you been studying trading, and how many trades have you made? If you haven’t made at least one trade per week that you’ve been studying trading, then you’re doing something wrong. You learn how to trade by trading. It’s best to have a mentor you trust to guide you, but they can only serve as a guide.

The solution to your problem of analysis paralysis is an Emperor Has No Clothes moment: everyone in this game is guessing, because that’s all you can do. The only people who are certain are the insider traders who eventually get thrown in jail. Be sure not to equate guessing with random choices. I am a strategic and analytic guesser, but because no trade is ever a certainty, they ultimately remain guesses nonetheless.

Many people say that traders should be comfortable with risk, but I’ve always thought that was terrible advice. The best traders I know are really uncomfortable with risk and seek to avoid it all costs. They only want to take risk when they’re absolutely sure they’re going to be compensated for it, and they err on the side of caution and career longevity over home-run profits.

The better advice is that traders should be comfortable with uncertainty, which is different from risk. A trader who is comfortable with uncertainty embraces process over results, and can recognize that a good trade can sometimes lead to losses just as a bad trade may sometimes lead to profits. Only a trader that embraces uncertainty can summon the requisite courage to push himself to raise his size and up his game. So many traders reach a moderate level of success and prefer the certainty they’ve established over the uncertainty that comes with truly challenging yourself to get better.

If you’re suffering from analysis paralysis in your trading and you feel constantly unsure of what you’re doing, the only way to alleviate that feeling is to keep trading, review your work, and get comfortable with the high level of uncertainty in trading. You’ll never be sure of anything, which is both frustrating and what ultimately makes trading so much fun.

There’s no Holy Grail and there never will be, as markets are dynamic and constantly changing. Faced with uncertainty and the most complex game imaginable, your job as a trader is to carve out a niche through both analysis and action. If you have action without analysis, you’re just blindly throwing money away and you’ll never improve. If you have analysis without action, you’ll never dip a toe in the water to give it a shot.

Find out why you should be cautious of this resistance level in AAPL.

Learn why the fiscal cliff talks will dominate the markets in the coming weeks and the key levels to keep in mind in BIDU, a stock everyone needs to keep on their radar.

Mark Cuban recently gave an interview to the Wall Street Journal blog MarketBeat where he discusses his thoughts on high-frequency trading (HFT). You can read the interview here: Mark Cuban: High-Frequency Traders are The Ultimate Hackers. Before I discuss the interview and Cuban’s thoughts on HFT, let me say the following:

I like Mark Cuban a lot. I think he’s an awesome business mind and is really entertaining on Shark Tank (which happens to be my favorite show). Nothing in this article should be construed as an attack on Mr. Cuban, whom I respect a lot.

My Qualifications

Before we get into the nitty-gritty, it’s important to clarify that I feel uniquely qualified to talk about the subject of HFT. As an active day trader, I trade millions of shares of stock every single month. In fact, it’s no exaggeration to say that I trade more shares in a given day than most people will trade in their entire lives.

In the course of that trading, I am constantly doing business with high-frequency traders. Given their ubiquity in the current market environment, dealing with HFTs is unavoidable. Because of that, I’ve had to study HFT in great detail in order to stay competitive. Unlike the HFTs, I don’t have the same advantages of speed or automation like they do as my trading is completely manual (as opposed to automated).

Finally, unlike an employee at a HFT firm, I have nothing to gain through this line of argument. The discussed HFT rule changes will, in all likelihood, not affect me in the slightest. In fact, as I mentioned before, HFTs are my biggest competitors. I would probably stand to gain financially if HFT was outlawed tomorrow.

The Case For HFT

I’m going to first discuss the benefits of HFT before discussing Mr. Cuban’s attacks on it. HFTs, simply put, increase the liquidity of the marketplace substantially in a way that human market-makers couldn’t do. These liquidity benefits can be confirmed via a look at the average bid/ask spreads in the market as well as by qualified sources such as Gus Sauter, the former CIO of Vanguard, who estimates that HFT has cut transaction costs at the firm.

Just as automation has led to efficiency and cost savings in other industries, so too has it led to savings for the average investor as human market-makers have become obsolete. Now let’s run through Mr. Cuban’s claims, one-by-one.

Defending HFT

Cuban: “The only certainty in the software world is that there is no such thing as bug-free software. When software programs are trying to outsmart other software programs and hack the world’s trading platforms, that is a recipe for disaster.” 

While it may be true that there’s no such thing as bug-free software, the competitive nature of markets means that the weaker programs get destroyed by losing money so that the stronger ones may survive. Also, HFT’s aren’t trying to “hack” into the exchanges like some cheesy War Games ripoff. Cuban also doesn’t really elucidate the mechanism whereby HFT will surely lead to disaster.

Cuban: “And BATS couldn’t get their software right for their own IPO. Why? It should be easy. They’ve been doing IPOs in electronic markets for years. Why did it fail now? If they can’t get an IPO they completely control right, does anyone really think that the software that controls the hundreds of millions of human-free interactions a minute is really bug free and cannot fail?”

Cuban is right that the BATS and Facebook IPOs were debacles, but that’s not really the fault of HFTs. The reason those IPOs failed is because they couldn’t get the opening cross right, which is a different mechanism than standard trading because these IPOs use a single ECN to open trade in the stock. In standard trading, one can use multiple ECNs such that in the rare event one stops working, orders can be entered using an alternate ECN.

I do believe that Cuban is right that there is a remote chance of failure in any complex electronic system, but I don’t really see any viable alternative. Going back to writing out order tickets by hand and calling in orders to the floor is akin to using abacuses instead of calculators. Every large business in the world now depends on the cloud which has the same theoretical chance of failure as the markets, but the efficiency advantages more than make up for that remote chance of failure. The same holds true for the stock market.

Cuban: “How many times an hour are there failures across individual equities around the world because of software running algorithms battling each other for supremacy to make a profitable trade? We have no idea.”

We actually do have data on the number of times that trades fail or are broken on individual equities, as all trades are reported. In fact, you can even go to the NasdaqTrader.com website here to see whether systems are operating normally and to see if there are any regulatory notices about trades in particular stocks.

Given the number of trades that take place in a given day, the number of “failures” is astonishingly low. I would venture to guess that on most trading days, not a single trade has to be broken via a regulatory announcement in the U.S. equities markets.

Cuban: “And that’s before we even get to the possibility of nefarious or sovereign hackers getting involved.”

The potential threat of hackers is certainly real, yet they could also attack any of our nation’s other major systems (defense, infrastructure, electricity) as they are all electronic now too. The only other alternative is to revert back to the 18th century and trade stocks hand-to-hand under the buttonwood tree as they used to do it. Furthermore, HFTs didn’t cause electronic trading, but rather arose in response to it.

Cuban: “And the argument is horrible for another reason. If you’re an investor you shouldn’t care if the spread widened by a penny, nickel dime or quarter. If you’re anything but a trader the change is of no impact to whether or not the company will be successful and create returns for investors. In fact, that anyone even considers this a valid argument is a red flag that the exchanges are more interested in traders than investors.”

Liquidity benefits everyone, including investors (who pay less each time they buy and sell a stock) as well as public companies (who get to take advantage of the liquidity premium as public companies trade at higher multiples than private companies). Even if a company generates returns for investors, it doesn’t really matter if there’s nobody for an investor to sell his stock to without incurring significant transaction costs.

Cuban also inserts a false dichotomy between traders and investors, with the implication that only investors help companies raise capital via the public markets. In fact, the liquidity provided by short-term traders such as HFTs makes stock market investing more attractive (via decreased transaction costs), thus helping companies raise capital. If long-term stock investors had to wait days before buying or selling a particular stock, you could bet that stock market investing would dramatically decrease in popularity, thus hurting companies hoping to raise money.

Improving HFT

With all that said, I’m not so naive to think that all HFT is great for markets. A significant minority of HFT is what I term “predatory” in that it runs counter to the goals and interests of the market as a whole. HFT programs that provide phantom liquidity via rapidly entering and canceling orders do nothing to provide liquidity and unnecessarily tax the exchanges (who must deal with the quote traffic). Some HFTs make heavy use of “dark pools” of liquidity, trades that take place off the major ECNs and thus are difficult to track.

In order to deal with the nefarious aspects of HFT, I think it’s reasonable to regulate either the number of canceled orders vs. executed orders or perhaps institute a minimum time limit for entered orders to prevent excessive order cancellations. This would eliminate the phantom liquidity while preserving the liquidity benefits of HFT. Furthermore, attempts should be made to limit dark pool trading so that every trader can be on equal footing when it comes to executing orders.

I’m excited to announce that I’ve been featured in an article in the current issue of Smart Money magazine, entitled “Inside the Life of a Stock Flipper.” Click on the image below to read the article:

 Let me know what you think about the article in the comments below!

Welcome to my May 2012 Monthly Trading Report!

Every month I write a detailed report about my trading.

I do this not only to keep track of my own progress, but also to share with you what’s working in today’s market and what’s not.

I share these reports to motivate and to be transparent. As someone who publishes information about day trading, I feel that it’s important to share my own numbers to prove that unlike so many “gurus,” I’m an actual trader. I want the readers to be able to see the ups and downs of being a professional day trader without relying on secondhand sources or hype.

May Market Recap

May was characterized by broad-based weakness throughout the market, resulting in one of the worst months in years for stocks. The DJIA lost 6.2%, the S&P 500 lost 6.3%, and the Nasdaq lost 7.2%.

The biggest trading event of the month was the Facebook (FB) IPO, although it too succumbed to the overwhelming malaise that gripped equity markets throughout the month as it collapsed from its opening price of $42.00.

My Trading

I’m pleased with how I traded this month, particularly with how I traded Facebook. Facebook accounted for roughly half my month’s profits, and it represented an ideal trading stock for my style as it was volatile yet also liquid enough to take large positions.

I did feel I was a bit unprepared for the sharp downmove in the markets, as the month reminded me a bit of how stocks used to trade during the financial crisis in 2008. I definitely fought the trend a bit too much by picking bottoms in certain stocks instead of riding the momentum down. I adapted my trading a bit better towards the end of the month to account for the weakness in the overall market.

My Results

Before getting to my results, I do have to share a few caveats. Don’t assume that my results are typical or easily achievable. By sharing my results, I’m not implying that you can expect to achieve similar results. Your results will vary, based on your trading skill, account size, and commission rates, among other factors.

I trade a substantial account with many millions of dollars in buying power. I also have access to very low commission rates through Great Point Capital, my prop firm. Your account size and commission rates may differ.

My results include commissions paid, ECN fees, SEC/Nasdaq/SIPC fees, and stock locate fees. The only thing my results don’t include is the small percentage of profits that I split with my prop firm. As always, my results have been verified by Great Point Capital, the FINRA-registered broker-dealer where I trade.

Verified May 2012 Results: +$207,744.30

My Goals For Next Month

1. I want to take a little bit of time off to enjoy the brief Chicago summer as I can feel the signs of burnout slowly creeping in.

2. I want to trade defensively throughout June, a month I anticipate to be slow as the summer trading doldrums begin.