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Suitable
Instruments for Day Trading
Basic
Criteria
What basic characteristics should an instrument have in order to
make it a suitable candidate for potential day trading? In our view,
the most important attributes are:
Liquidity
Volume
Volatility
Price Transparency
Each of the above attributes will be discussed separately below.
1.
Liquidity
Liquidity, broadly defined, is the existence of a sufficiently large
number of buyers and sellers in an instrument to permit one to quickly
and easily acquire or exit a position in the instrument. Good liquidity
is important to the day trader who requires fast executions at relatively
predictable prices. High liquidity also has the additional advantage
of (generally) reducing the bid-ask spread for a particular instrument
therefore reducing execution costs for the day trader. There is
no quantitative measure of liquidity. Liquidity is based on a number
of factors, the most important of which are:
Volume
of transactions on the market (the higher the better)
Number of contracts/share outstanding (the more the better)
Breadth of ownership ( the higher the number of traders the better)
Number of market makers (the more the better)
2. Volume
Volume is a component of liquidity and is easily measurable. A good
day trading instrument should trade at least 500,000 shares a day
and preferably much more. instruments with high volumes permit the
day trader to acquire or sell a large quantity of instrument without
unduly affecting the price of the instrument.
3.
Volatility
Volatility refers to the actual or expected price movement of an
instrument (either up or down) over a particular period of time.
In the case of day trading, the period of time to look at is a single
day. instruments which tend to exhibit little movement in price
during a typical trading day are not good candidates for day trading.
A good rule of thumb is to select for trading only those instruments
which tend to fluctuate in price substantially in a typical trading
day.
4.
Price Transparency
Price transparency refers to the ability to obtain information as
to the order flow for a particular instrument. This is also referred
to as market depth.
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