Sammy Chua John Wiley & Sons, Inc. Sammy Chua’s DAY TRADE Your Way to FINANCIAL FREEDOM 2 ND EDITION 14762_Chua_2p_ffirst.j.qxp 2/2/07 11:26 AM Page i Copyright © 2007 by Sammy Chua. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. Wiley Bicentennial Logo: Richard J. Pacifico All graphics courtesy of CyberTrader. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. 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Title: Day trade your way to financial freedom. II. Title. HG4515.95.C49 2006 332.64′2—dc22 2005031909 Printed in the United States of America 10987654321 14762_Chua_2p_ffirst.j.qxp 2/2/07 11:26 AM Page ii CONTENTS PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 CHAPTER ONE An Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 • The Stock Markets • The Exchange System • NYSE Time Lines • Listed Stocks • The Specialist System • Who’s Who on the Exchange Floor • The SuperDOT System CHAPTER TWO The Big Board and Nasdaq . . . . . . . . . . . . . . . . . . . . . . . . . 13 • The Over-the-Counter Market (OTC) • NASD and Nasdaq • Nasdaq Is a Negotiated Market • Understanding Market Makers • Information Is Power • Nasdaq Service Levels I, II, and III • Comparing the NYSE and Nasdaq • Electronic Communications Networks (ECNs) • Regulatory Framework • Quick Quiz 14762_Chua_2p_ftoc.j.qxp 2/2/07 11:26 AM Page iii iv CONTENTS CHAPTER THREE Brokerage Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 • Selecting a Brokerage • Execution Speed • Reliability • Order Routing • Price • Service • Other Online Brokerage Features • Types of Accounts • Types of Positions • Types of Trading Orders CHAPTER FOUR Direct Access Order Entry System . . . . . . . . . . . . . . . . . . 39 • Nasdaq Direct • SuperMontage • TotalView • ECNs • SuperDOT • Order Execution Systems Review CHAPTER FIVE Elements of Successful Trading . . . . . . . . . . . . . . . . . . . . . 47 • Minimum Requirements to Begin Trading • Psychology of Trading • Risk Management • Trading Methodology CHAPTER SIX Trading Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 • Scalping • Intraday-Trend Trading 14762_Chua_2p_ftoc.j.qxp 2/2/07 11:26 AM Page iv CONTENTS v • Swing Trading • Long-Term Trading • Back Testing CHAPTER SEVEN Technical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 • Charts • Identifying Support and Resistance • Trading Strategies • Trendlines • Gaps • Basic Chart Patterns • Volume Analysis CHAPTER EIGHT Candlestick Charting Techniques . . . . . . . . . . . . . . . . . . 115 • Spotting Heavy Buying and Selling Pressures • Comparing Buying and Selling Pressures • Spotting Indecision with Candlesticks • Understanding Intraperiod Activity • Candlestick Positions • Bullish Patterns • Bearish Patterns CHAPTER NINE Spotting Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 • Technical Indicators • Key to Using Indicators • Moving Averages • Moving Average Convergence Divergence • MACD Histogram • Stochastic Oscillator • Relative Strength Index 14762_Chua_2p_ftoc.j.qxp 2/2/07 11:26 AM Page v vi CONTENTS • On-Balance Volume • Accumulation/Distribution • Futures and Pivot Points • Conclusion CHAPTER TEN Preparing for the Open . . . . . . . . . . . . . . . . . . . . . . . . . . . 177 • The Trading Day • Do the Research • Manage Risk • Set Alerts and Trading Screens • Intraday Trading • Market Indices • Other Market Indicators • Direction of Market Trends • Keep a Trade Journal CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193 INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 14762_Chua_2p_ftoc.j.qxp 2/2/07 11:26 AM Page vi PREFACE W HEN SAMMY CHUAASKED ME to edit his new book on day trad- ing, I jumped at the chance. As a reporter for Investor’s Business Daily, I had covered day trading for several years. Too many of the day trading gurus I wrote about were interested only in getting novice traders into their shop, bleeding them dry, and then shoving them out the door when their cap- ital had run dry. Sammy Chua was an exception. He has made a fortune using trading methods that I believe to be superior to the many other methods I have covered. Now he wants to teach others how to succeed in this miraculous profession. There is no hidden agenda with Sammy. His zeal to teach is genuine and heartfelt. He wants to teach beginners to protect their capital and to avoid the psychological traps that often spell disaster for new traders. Sammy Chua wants you to have the same suc- cess he has had. Day trading has come a long way in the past 10 years. It is a risky occupation, but a small group of talented people have developed ways of lessening the risk and increasing the potential for profit. Sammy Chua is number one on this list. Here’s a short version of his strategy: The controlling factor in day trading is, according to Sammy, supply and demand. If demand for a stock is great, the sup- ply will decrease, driving the stock price upward. If demand is poor, supply will increase, driving the stock price down. You don’t need a broker or an army of research analysts to tell you when the laws of supply and demand are pushing a stock up or down. Just pay attention to what Sammy has to say in this book. Concentrating on supply and demand is liberating. It frees the trader from the onerous chore of picking stocks based on the industry they represent. Sammy once drove this home to me in a phone conversation. He talked about making a good profit the day before on Corning. I remarked that I liked Corning, because the company was in the rapidly growing fiber optics business. Sammy took a deep breath and said, “Pete, I don’t know what Corning does. I don’t care what they do. I don’t know anything about any of the companies I trade. 14762_Chua_2p_fpref.j.qxp 2/2/07 11:31 AM Page vii viii PREFACE All I know is the stock generated a strong buy signal based on several indicators. Institutions are jumping in big-time, which means supply is dwindling. That’s all I care about.” And that’s all day trading should be about. It’s about supply and demand, learning to read indicators and volume trends, and sticking rigidly to a loss pre- vention program. But I’ll let Sammy Chua explain this to you. He is a proven win- ner in the fine art of day trading. Learn and enjoy. Peter McKenna Editor 14762_Chua_2p_fpref.j.qxp 2/2/07 11:31 AM Page viii INTRODUCTION D AY TRADING IS THE MIRROR OPPOSITE of the buy and hold strat- egy. It means trading frequently, trying to capture small profits while limiting risk. You do not buy a stock and hold it for years. Good traders learn what makes stock prices move up or down, and they use this knowl- edge to make money on a daily basis. Consider, for example, just one of the important bits of knowledge this book will teach you: the theory of supply and demand as it applies to stock prices. When institutions such as brokerages and mutual funds buy huge amounts of a stock— IBM, for example—the available supply of that stock will diminish. This in turn will drive the price of IBM stock upward. A day trader who learns to spot stocks that are under heavy accumulation can use that knowledge to catch a ride on IBM as its price goes up. The same is true in reverse. If institutions are selling a stock, it’s supply will increase, driving the price down. An alert day trader will short this stock for a brief time as its price falls. When done correctly, day trading can help investors avoid the periodic losses that come with the traditional buy and hold strategy. Since the first stock was traded more than 200 years ago in New York City, the overall direction of the mar- kets has been upward. For this reason, the buy and hold strategy makes sense if you want to hold stocks for several years. However, the market does not make this upward climb in a straight line. There are periods of months and sometimes years when prices come crashing down or move sideways. This is the classic bear market. Long-term investors who get caught in these downdrafts can be badly hurt. Suppose, for example, that you put a lot of money into Lucent Technologies when it was trading near $20 in 1999. The stock soared to nearly $80 by January 2000. Everything was rosy. Many long-term investors held onto tech stocks such as Lucent, thinking they would go up forever, providing the money for retirement or college tuition or a new car in the years ahead. Lucent was their nest egg. 14762_Chua_2p_cintro.j.qxp 2/2/07 11:31 AM Page 1 2 INTRODUCTION But things turned nasty in 2000 and 2001. The tech sector collapsed and the mar- ket came tumbling down. It bears repeating that the market cannot go up forever. Something always brings it down. Lucent now trades at about $3. Investors who bought Lucent in 1999 and held on have been left with next to nothing. When the tech bubble burst, a day trader who understood the supply and demand theory mentioned previously would have spotted Lucent, or any num- ber of other tech stocks. They would have seen the selling pressure and shorted the stock, making money immediately. The rewards and risks of the day trading strategy are immediate; they are not long-term promises that may or may not materialize. This is a great time to be a day trader. Although day trading has been around for several years, recent changes in technology and securities laws have opened it to simple folks like you and me. Today, we can trade from any location. All we need is an Internet connection and a computer. We also have the ability to place orders directly into the stock exchanges, which is almost like buying a seat on the exchange itself. Day trading is not for everyone. To be successful, you have to love what you do. If day trading does not fit your personality, you will not last long. For example, day trading can be risky. You can lose money in a few seconds. Risk taking comes naturally to some people but shakes others to the core. If you feel comfortable buy- ing only companies with strong, long-term fundamentals, then short-term trading, particularly day trading, is not for you. But if your desire for financial freedom is strong enough, if you are willing to develop the discipline it takes to trade success- fully, you have the right mentality to be a frequent trader. Before we continue, let me make an important point: This book covers many different trading strategies. You do not have to master all of them to be successful. Traders who concentrate on just one or two strategies almost always become suc- cessful faster than traders who want to know everything before they take the plunge. The same is true in all professions. Both general practitioners and heart surgeons, for example, are doctors. But heart surgeons are specialists and enjoy more success than general practitioners. Be the heart surgeon and learn to special- ize in one strategy before moving on. 14762_Chua_2p_cintro.j.qxp 2/2/07 11:31 AM Page 2 [...]... set the parameters Also, find out whether the charts are current, whether they load quickly, and whether they are real-time or 15-minute-delayed resentative should not take more than a few min- News and research services Some brokerages provide utes to answer your call real-time newswire services Others provide news at their A good online brokerage should have a toll-free service desk that can answer... day traders? What does all this back-and- is today Most day traders, however, never set foot forth mean to the day trader? These are the basics inside the NYSE Including the NYSE, there are Learn them well seven stock exchanges in the United States, but the In the United States, stocks are bought and sold NYSE is the granddaddy of them all The others in two different venues: stock exchanges and over-... market price These are the orders and prices that must be THE SUPERDOT SYSTEM matched Floor brokers Brokers usually represent big-name brokerage firms They handle large (block trades) or sensitive orders The brokers deliver these orders to the specialists They are allowed to negotiate orders with the specialists or other floor brokers in the presence of a specialist Floor clerks These people deliver... stocks traded on the NYSE are not as volatile as buyers and sellers They are expected to maintain OTC stocks This can be an asset or a liability to the an orderly and fair market When there is an excess day trader However, some large-cap stocks, even of buy or sell orders, making it impossible to though they trade on the NYSE, are volatile match orders evenly, the specialist steps in There Energy stocks... Level III permits market makers to enter bid and Bids and offers offer prices into Nasdaq It also provides a means Size of the market (for both market maker and ECN) Time that the market maker placed or refreshed a bid or offer by which the trades are reported to Nasdaq Level III is to the market maker what ECNs are to the day trader It’s a system by which they can adver- Time of each executed trade. .. the stock- from one investor to another How is this done? trading universe The NYSE was created in 1792 by Who are the people who execute these trades for 24 traders who got together to trade a few shares in investors? How do you get the best price on your two small, local companies From this humble order? Which electronic routing systems are the beginning, the stock market grew into the beast it best... tise to buy or sell securities that appear on Level II Price of each executed trade Market makers use Level III to advertise on the Size of each executed trade national system (Level II) 14762 _Chua_ 2p_c02.j.qxp 2/2/07 11:32 AM Page 20 20 SAMMY CHUA S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM COMPARING THE NYSE AND NASDAQ required to display quotes for the stocks they are making a market in Nasdaq stocks... system with dual processors, check to see if between you and the market A good direct access the trading platform you use supports them Com- broker will have a direct connection to several puter memory is inexpensive today, so maximize it ECNs ECNs tend to execute orders a lot quicker than market makers The more ECNs you have ORDER ROUTING direct access to, the more choices you have to get your orders... the old days As you can Member firms A big-name brokerage firm that has a see, getting a trade executed in the old days took seat on the NYSE If your brokerage firm is not a member, time The trader called a stockbroker and placed the your order will pass through another firm that is a member order The stockbroker called the order in to the trading desk The desk relayed the order to a floor Floor traders... phone Because there is less han- access to their accounts But they do not provide dling involved, they charge lower commissions high-speed executions These brokerages are best than full-service brokers for people who invest rather than trade Brokers like Charles Schwab, Quick & Reilly, One word of caution: Full-service brokerages Fidelity, TD Waterhouse, Scott Trade, and others claim to have great research . different venues: stock exchanges and over- the-counter markets (OTCs). This chapter explores the differences between the two systems, particu- larly the differences that will affect your career. represent big-name bro- kerage firms. They handle large (block trades) or sensitive orders. The brokers deliver these orders to the specialists. They are allowed to negotiate orders with the specialists. orders in the old days. As you can see, getting a trade executed in the old days took time. The trader called a stockbroker and placed the order. The stockbroker called the order in to the trading