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A day-trader's manual

Devangshu Datta

Would you like to sit down at a table with Rs 10,000 and get up a few hours later with Rs 15,000? No, I'm not referring to the tables at the Casino Royale. Many respectable, middle-aged people chase this particular fantasy across stock screens everyday.

Most novices think stock trading is complicated. It isn't: call a broker, place a buy or sell order, hand over the cheque or stock and the transaction's done.

The complications arise only when the trader doesn't have enough cash in the first place. Or the trader doesn't actually own a stock that he sells (because he thinks the price will fall). Well, it is still possible to buy or sell! But only inside the narrow window of a single trading session.

The trader has to make coupled trades - buy and sell in the same session. The trader places a buy order. He sells the stock in the same session.

Now he will either receive or pay the difference between the two prices. But he doesn't need to commit the entire amount. He has leveraged his financial resources by accepting a time limit.

A trader can easily execute the couple in the opposite order. There is nothing to stop a trader from first selling a stock and then buying it back in the same session. He still stands to gain or lose the difference.

Financial leverage is the keystone of day-trading. Traders are happy to day-trade because they can stretch resources further. Brokers are happy to offer lower brokerages to day-traders because the coupled trade comes without the need for delivery.

The processes of day-trading aren't complicated. The broker will demand that the trader puts a cash deposit down as his "margin" before he accepts day-trades. The trader can "leverage his margin", three times at least.

Translating the jargon, a margin of Rs 10,000 can be traded up to a limit of Rs 30,000. The profits or losses are credited or debited daily from the account. This is why day-trading is often called "margin-trading". (It is also known as "jobbing").

A day-trader can log huge profits because of leverage. Say, for example, a day-trader has a Rs 10,000 margin and a limit of Rs 30,000. He trades Rs 30,000 and the position goes, say, 5 per cent in his favour.

He gains Rs 1,500 and pays a brokerage of 7 paise per Rs 100 - approximately Rs 42 total. Net he makes Rs 1,458 on Rs 10,000 - in a single day.

In a big stock, daily moves are limited to 8 per cent in either direction of the opening price. The daily high could be 17 per cent above the daily low. Multiply that 17 per cent by a leverage of three and a day-trader could make 51 per cent in a single session. Of course, such a massive move is not likely but big swings do happen.

In practice, day-traders make dozens of trades, flitting from stock to stock in search of profits. Some traders concentrate on low-priced, high-circuit stocks where the fluctuations are greater. These guys are the high-rollers, prepared to bet their entire capital in double-or-quit games.

Day-trading is a very dangerous pursuit. For one thing, those tiny brokerages add up - you must multiply the brokerage by six to calculate your actual percentage (at a leverage of three and for a buy-sell couple). Every loss is also magnified by the leverage - it is quite possible to lose half your capital in a session.

Brokers love day-traders. The money is there, so there's no fear of default. There's no paperwork and headache of transfers. Just deduct the commission at the day's end.

Plus, the broker gets access to the margin money interest-free. Some brokers ask you to deposit the cash directly. Others offer the option of setting up a joint account in a bank. You put in the cash, the broker can take it out.

A ball-park estimate is that, for every day-trader who makes a decent living, there are around 30 losers. It's a full-time job because little fluctuations can wipe out everything.

It's difficult to track more than a couple of stocks continuously. Fundamentals have little to do with the dips and skips on a day-trader's map. The trader works with statistical trends and very few people have the combination of nerves and mathematical understanding to succeed at that.

What day traders must know

The following rules don't guarantee success but not following them guarantees failure:

1. Always keep a stop loss - a cut-off point at which you will reverse a trade and lick your wounds.

2. Move the cut-off up/down if your position becomes profitable. Say, you buy at Rs 100, with a stop at Rs 95. The stock rises to Rs 105 - move your stop to Rs 103 and lock in that profit.

3. Don't commit more than 1 per cent of your capital to a single trade - that is, with a leverage of three, limit each position to 3 per cent of capital. Trade often if you like, but don't cross that limit.

4. Concentrate on a small set of stocks - you need high volatility and high liquidity. Do the numbers. Make emergency arrangements for borrowing your favourite stocks.

5. Practice trading in front of a live screen without committing money for at least a week, preferably a year, before you actually trade. Fast reflexes and familiarity with the colour-coded information onscreen is a must.

6. Keep an alternate broker. Brokers, who handle a high percentage of day-traders, often land up in trouble. They do strange things with the margin money - this is a fact of life!

7. Make emergency arrangements for funds and stock-borrowing. If you cannot "complete" the couple, you will need to deliver stock or pay. This is another good reason for a low per-trade limit.

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