How to select stocks for intraday trading?

Intraday trading is all about initiating and closing out your trades on the same day. For example if you buy 500 shares of Reliance in the morning at Rs.920 and sell it by evening at Rs.928, then you can book a profit of Rs.4000 (500×8) intraday. This trade does not result in any delivery as your net position at the end of the day is zero. You can also sell the stock in the morning and buy it back in the evening if you believe that the stock is likely to go down. In fact, if you want to short sell stocks (without delivery), then the only way you can do it in rolling settlements mode is intraday.

The most important step for an intraday trader is selecting the stocks to trade intraday. You need stocks that can give movement and at the same time are predictable. Here are 6 such factors you should consider when you select stocks for intraday trading.

Is the stock liquid enough?

Market liquidity is the most important consideration when looking at a stock for intraday trading. After all, you do not want to enter into a position and they worry about how you are going to exit the same. This problem normally exists in small stocks and more of the F&O stocks and the higher end of mid cap stocks are normally quite liquid. But how do you measure liquidity. One the basic measures of liquidity is to view daily volumes as a proportion of market capitalization.

Liquidity = Average daily volumes / Market capitalization

While there are no hard and fast rules, a minimum liquidity ratio of 10% should be the benchmark to consider a stock for intraday trading.

Can you buy or sell the stock with low impact cost?

What do we understand by low impact cost? It is the impact on the stock price when you place a large buy or sell order on the stock. When impact cost is high, the risk of intraday becomes too high and hence such stocks should be avoided for intraday trading. High impact cost means that the price at which you will get the stock could be unfavourable to you in case of large orders. This will change the economics of your intraday trade. Prefer stocks that have low impact cost, which is normally another proxy for liquidity.

Is the stock widely owned?

You can check out these details in the ownership pattern of the stock which is available on the websites of the exchange. You can also get cues from the trading pattern of the stock. Stocks that are not widely owned will be more volatile and will also hit circuit filters easily. That is because a handful of market operators will be able to corner these stocks quite easily if they are not widely owned. As an intraday trader, always prefer stocks that are liquid and widely owned. That will reduce your risk substantially.

Does the stock sustain narrow tick spreads?

This is again an extension of the liquidity and the impact cost argument. But since we are talking about an intraday trader, the tick becomes very important. The tick is the minimum gap between two orders. There must be enough volumes on each tick to qualify for an intraday trade. You do not want to place an order and realize that your order execution has actually happened several ticks away. In intraday trades, you try to capitalize trends and so you normally place market orders. Hence the tick gap becomes a key consideration for intraday stock selection. Smaller the tick gap, the better it is for you.

Does it show clear and decipherable chart patterns?

As intraday trader, you need to rely heavily on technical charts. Of course, you must develop the capacity to read charts on your own. But above all, ensure that the stock depicts clear chart patterns. It is not possible to trade in a stock that does not have sufficient history or which does not depict a clear pattern. Only with a long history, you can decipher patterns and then trade for a repeat of these patterns.

What is the price sensitivity to news flows?

An intraday trader, typically, relies on two factors to trade viz. chart patterns and sensitivity to news flows. You cannot trade intraday in a stock that does not react to news. Basically, you are look at stocks that are extremely sensitive to news. That is why your strategy of buying on expectations and selling on announcements can actually work in practice.

Intraday trading is as much about getting the stock list right as it is about discipline. The key here is to keep your stock universe limited so that you can do justice tracking these stocks in terms of fundamentals, technicals and news flows.