Day Trading Small Accounts

Some futures brokers provide significant leverage and very low margins for day traders. It is relatively easy to find brokers that will allow trading with margins as small as $500 per contract. The exchange minimum margin for the e-mini S&P 500 futures contract would be about $5,000 and other contracts also carry margins of at least a couple thousand dollars. This means that the day trading margin makes this contract available to more traders.

Day trading is a subject associated with dreams of wealth, and carries images of hyperactive, high risk trading. In the internet bubble of the late-1990s, day traders captured the public’s imagination. Trying to capture a few pennies on each share they traded, they usually operated on full margin all day and closed their positions at the close. Frenzied trading would start again the next morning and continue throughout the day.

Some of these traders made money, but many lost. Studies at the time showed that 80-90% of day traders closed their accounts with a loss. We can never know if studies like this actually show what’s going on in the markets or if they only capture a small piece of the activity at a few firms. What we do know is that it’s logical to accept that most day traders failed. They didn’t understand the markets and were motivated by hope and greed. It’s safe to assume that most lacked a well-developed trading plan.

If you could travel back in time, it would be relatively easy to profit from the day traders. By definition, day traders will close out open positions every day and hold cash in their trading account overnight. They will be selling stocks on the close and buying stocks on the open. Traders willing to carry risk overnight could simply do the opposite. Buying the ten most active stocks each day on the close and selling them shortly after the open the next morning would be profitable at that time. In fact, that strategy should work whenever markets are going up. It will lose money when the major indexes are in a bear market. News does have a tendency to move stock prices on the open, and this simple idea takes advantage of that principle. It’s a logical approach to trading.

This may not meet the strictest definition of day trading because positions are held overnight, but it illustrates the idea that short-term trading doesn’t need to be fast and furious. A thoughtful approach can allow small traders to day trade and take advantage of low margins to rapidly increase the size of their trading account.

For those with the time to follow the markets, a number of strategies can be used to day trade. Over very short time horizons, a number of academic studies have shown that markets exhibit mean-reverting behavior. In trading terms, this means that the prices will move up and down around a moving average on the charts. Traders can sell when prices are too far above the moving average and buy when they fall too far below it.

That brings us to the question of how to know when prices have moved too far. Bollinger Bands® always help provide an answer to that question. For example, on a 5-minute chart, we can use a 20-period moving average with Bollinger Bands and quickly generate trade signals. Sell short whenever prices move above the upper Band and buy when prices fall below the lower Band. Bollinger Bands are calculated with standard deviations and they are designed to contain 95% of the price action. The Bands are recalculated with each bar and adapt to the market action. That makes this a good system for short-term traders.

The problem with even a great system for short-term trading is that few people really have the time to follow the markets all day. Time is most likley the problem that makes day trading impractical for so many. However, if you can follow the open, then a range breakout system could be used. It requires entering two orders shortly after the open and that’s it.

Among the earliest references to opening range breakout systems is a book that Toby Crabel wrote in 1990, “Day Trading With Short Term Price Patterns and Opening Range Breakout.” Although long out of print, used copies are available on starting near $300 and EBay bidding wars have led to traders paying thousands of dollars for the book. It offers specific and detailed rules for trading different commodities, rather than the general approach presented here.

This strategy is based upon the idea that the opening range often sets the tone for the rest of the market day. The opening range is defined as the difference between the highest price and the lowest price in a certain timeframe, usually the first 15 minutes or the first 30 minutes of trading. Any other timeframe can be used. The advantage of this strategy for the time-pressed day trader is that all the data is known at a certain time every day and trade entry can be scheduled in advance.

Breakouts above or below that range often show the market direction for the rest of the day. Falling back into the range can mean the market is directionless and traders may find more satisfaction on the golf course that day.

As an example of the opening range breakout, we could watch the first 30 minutes of the market action and measure the opening range. We then add and subtract half of that value to the high and low to identify the buy and sell points. Specifically, if the S&P 500 opens at its high of 1325 and then falls to 1315 during the first half hour of trading, the range is ten points and half of that is five points. A buy order would be placed at 1330 (which is five points added to the range high) and a sell order would be placed at 1310 (five points from the low of the opening bar). Orders could be set as “one cancels other” which means the first one to trigger is executed and the other order is cancelled. An exit order, market on close, would be also be set up. These order types are commonly found in online platforms.

This is a day trading strategy since the positions are not held overnight. It’s suitable for those who can’t spend all day monitoring markets. Of course it is best to be able to place orders every day, since you never know when the big move will occur.

Ideally, an account would trade at least two strategies to take advantage of market moves. A long-term trend following system could be combined with the opening range breakout and used in a small account. The trader would need enough margin to cover at least one contract overnight, and it could be something like corn which has a margin around $2,500.

The short-term system could be the opening range breakout, using the e-mini S&P 500 contract. Trend following systems tend to work well in the long-term. A moving average envelope system is a well known way to implement this strategy and weekly data could be used to minimize trading. Price bands are created at some percentage above and below the moving average, for example 5%, forming an envelope for the price. Buys are taken when price moves above the upper envelope and the position is reversed to a short when price falls below the lower envelope. This system is always in the market with either a long or short position.

Most traders like to add a stop loss, but this generally reduces profits and increases the maximum drawdown of the trading system. Exit strategies will be covered in the next article.

At a discount broker, it’s possible to day trade with fifteen minutes a day and an account value of less than $1,000. With about $3,000 a fully diversified trading account is possible. In a great market, great being defined as highly volatile, it might be possible to make an average of 10 points a week in the S&P 500 which would be $26,000 a year. Unfortunately for traders, markets are not always volatile and gains of less than half that amount are more likely.

By Michael J. Carr, CMT