Day trading has a reputation as being risky, and it can be if all you do is take a punt on anything that moves. Technical analysis is a more methodical approach, but is it useful for day trading?
Technical analysis is useful for day trading since its trend-following and range trading tools apply even on short-term time-frames. From moving averages to channel breakouts, once backtested and utilized with proper risk management, technical analysis is a valuable part of a day trader’s toolbox.
So, technical analysis does translate well into the shorter horizons of day trading. Let’s go over the ins and outs of day trading and how technical analysis can be used to your benefit.
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Table of Contents
What Is Day Trading?
Day trading is all about the short-term. Day traders look to exploit volatility in the markets and enter trades that they exit by the end of the day. They look for trading opportunities on intraday time-frames. By that, we mean time-frames of minutes, not hours or days.
Some day trading can involve trades that are over and done with very quickly. Often, the idea is to profit from small moves using large positions.
Other day traders look for trades that last longer. Sometimes they might last for the whole trading session. It’s typically this type of day trading that technical analysis can help.
What Is Technical Analysis for Day Trading?
Technical analysis for day trading is much the same as it is for longer-term investing – it still starts with historical prices and volume. From that information, traders try to predict the direction in which price will move next.
It’s just that the price history on a day trader’s radar is more likely to be on a 5, 10, or 15-minute chart than a daily or weekly chart. The patterns you see on longer time-frame charts do show up on these shorter time frames. After all, the shorter time-frames are a zoomed-in view of what’s happening on the daily level.
Obviously, the data you’ll be looking at for day trading will be real-time, so the price action can unfold quickly.
Which Technical Analysis Strategies Can You Use for Day Trading?
If you’re day trading, you’re often looking to profit from trends. Even for a day trader, the old adage, the trend is your friend applies. So, you’ll want to look at tools that let you ride momentum in markets that are trending.
Another day trading strategy involves trading the swings of a market that’s in a trading range. When in such a range, prices tend to bounce between the top and bottom of that range.
Technical analysis has the tools to enable day traders to capitalize on both types of moves. So, let’s look at these now.
Technical Analysis for Day Trading Trends
What technical analysis tools can help you with day trade trends? Well, they’re the same tools you’d use for longer time frames, as you’ll see below.
Moving Averages
The most common trend tool is the moving average. In a trend, a moving average can act as support or resistance: you can enter trades at those points if you want to day trade trends.
As with longer-term charts, moving averages on intraday charts have customizable settings. So, you can switch between different types of moving averages. The main choices are simple, weighted, and exponential moving averages. And you can change the moving average period, which is the number of bars in the calculation of the average.
In the following video, you can learn about the calculations for each moving average type. It also provides some pointers for choosing which type to use and the period to select:
While that clip has helpful guidance on settings to help get you started, you need to be careful. You shouldn’t choose random settings and then jump straight into day trading. As with trading on longer time-frames, you’ll need to backtest.
Backtesting will let you see what works on an intraday level in the time frame you’re trading. If you don’t backtest your settings, you’ll be gambling, and that’s not what technical analysis is about.
You can see why backtesting is so crucial from a 2016 study. It looked at various technical indicators in foreign exchange trading, including moving averages. The notable takeaway for us is the study used many different settings to test each indicator.
In the case of the moving averages, there were 12,780 different settings. Some worked well, but some didn’t. What’s more, there were different returns from even the successful settings. Performance varied depending on the market traded.
A 2020 study, titled – ‘Technical trading and cryptocurrencies’, confirmed these findings. This study used a similar group of indicators in cryptocurrency trading.
So, it’s crucial to carry out backtesting for each setting on each market you want to trade. Without backtesting, you’ll undermine the usefulness of technical analysis for day trading.
Other Day Trading Trend-Following Technical Analysis Tools
Moving averages are one example of trend-following indicators that technical analysis provides.
There are many others. A couple of popular examples include:
- On-balance volume uses changes in volume to better predict prices.
- Filter rules use the percentages of prior prices to determine the best time to buy and sell.
- Channel breakouts use the current high and low points to attempt to recognize an early trend.
Filter rules and channel breakouts both proved profitable in the studies mentioned above.
Technical Analysis for Day Trading Ranges
As mentioned above, moving averages in trends work as potential support or resistance. So you use them to enter trades at the moving average in a trending market.
But what if a market isn’t trending? Well, technical analysis support and resistance levels aren’t limited to low-risk entry points for day trading trends. They’re also valuable in range-bound markets that move sideways.
If a market starts moving sideways, often you’ll see it form peaks and troughs. Usually, these are at similar levels to the previous peaks and troughs in the range. It means there’s a good chance that previous peaks in the range will act as price resistance.
In contrast, previous troughs will act as price support. So, if you want to day trade a range, you’d enter at the level of those prior peaks and troughs. Those levels should reverse the upward or downward moves within the range.
But, markets tend to range before breaking out into a new trend. Therefore, you must ensure you manage the risk of the range breaking.
It’s the same for any trading, not just day trading, and setting a stop-loss is crucial to proper risk management.
Technical Analysis for Day Trading Trend Reversals
Technical analysis also has useful tools that help day traders spot possible trend changes.
Moving Average Crossovers
A good example is moving average crossovers. This technique plots two moving averages, one shorter than the other. Crossovers between the shorter and longer-term averages mark possible trend changes.
This video explains how you can use moving averages in this way. It deals first with trend-following but then talks about how to use them for trend reversals:
Support and Resistance Breaks
If you get stopped out of a range day trade by a range breakout, that may mark a new trading opportunity. Because, in technical analysis terms, the chances are the market has started a new trend.
Technical analysis gives you a couple of approaches for day trading this. First, you can wait for the breakout to come back to the support or resistance it’s broken through. It might not always do that, but often it does.
If a new trend has started, what was support in the range will become resistance, and vice versa. If that happens, it provides some confirmation of a new trend. Waiting for this confirmation can make it less risky to enter a trade to follow that new trend.
Another approach is to look for volume confirmation of the breakout. A significant volume increase on the break suggests the breakout is genuine. So, you can enter a trade even without a retest of the breakout point.
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Conclusion
It doesn’t matter if you prefer to trade momentum or range-bound markets. Technical analysis can help you to spot potential opportunities.
But, as with all trading, don’t be too hasty to jump into trades. Backtesting strategies on your chosen time-frames and markets before trading them is crucial. Proper risk management is also vital, even if you intend to get in and out within minutes.
These additional steps will help you get the most out of technical analysis for day trading.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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