Stock Trading Strategies for Active Traders

Active trading is the act of buying and selling securities on the basis of short-term movements to profit from price movements on a short-term stock chart. The mindset associated with an active trading strategy differs from the long term buy and hold strategy found in passive or indexed investors. Active traders believe that short-term moves and capturing the market trend are where the profits are made.

There are various methods used to accomplish an active trading strategy, each with appropriate market environments and risks inherent in the strategy. Here are four of the most common active trading strategies and the built-in costs of each strategy.

Key points to remember

  • Active trading is a strategy of “beating the market” by identifying and timing profitable trades, often for short holding periods.
  • In active trading, several general strategies can be used.
  • Day trading, position trading, swing trading, and scalping are four popular active trading methodologies.

4 common active trading strategies

1. Trading day

Day trading is perhaps the most well-known style of active trading. It is often considered a pseudonym for active trading itself. Day trading, as the name suggests, is the method of buying and selling securities on the same day. Positions are closed the same day they are taken, and no position is held overnight. Traditionally, day trading is carried out by professional traders, such as specialists or market makers. However, electronic trading has opened up this practice to novice traders.

Active trading is a popular strategy for those trying to beat the market average.

2. Exchange of positions

Some people actually view position trading as a buy and hold strategy, not active trading. However, position trading, when performed by an advanced trader, can be a form of active trading. Position trading uses longer term charts – daily to monthly – in combination with other methods to determine the trend of the current direction of the market. This type of trading can last from several days to several weeks and sometimes longer, depending on the trend.

Trend traders look for successive upper or lower highs to determine the trend of a security. By jumping and riding the ‘wave’, trend traders aim to profit from both bullish and bearish fluctuations in market movements. Trend traders seek to determine the direction of the market, but they do not try to predict price levels. Typically, trend traders jump on the trend after it has established, and when the trend breaks, they usually exit the position. This means that in times of high market volatility, trend trading is more difficult and its positions are usually small.

3. Swing Trading

When a trend breaks, swing traders usually kick in. At the end of a trend, there is usually some price volatility as the new trend tries to establish itself. Swing traders buy or sell as price volatility sets in. Swing trades are typically held for longer than a day, but for a shorter duration than trend trades. Swing traders often create a set of trading rules based on technical or fundamental analysis.

These trading rules or algorithms are designed to identify when to buy and when to sell a security. While a swing trading algorithm doesn’t need to be exact and predict the peak or valley of a price movement, it does need a market moving one way or the other. A limited or sideways market is a risk for swing traders.

4. Scalping

Scalping is one of the fastest strategies employed by active traders. Essentially, it is about identifying and exploiting gaps between supply and demand that are a little wider or narrower than normal due to temporary imbalances of supply and demand.

A scalper does not try to exploit big moves or deal with large volumes. Rather, they seek to capitalize on small movements that occur frequently, with measured transaction volumes. Since the level of profit per trade is low, scalpers look for relatively liquid markets to increase the frequency of their trades. Unlike swing traders, scalpers prefer calm markets that are not prone to sudden price movements.

Costs inherent in trading strategies

There is a reason why active trading strategies were once only used by professional traders. Not only does having an in-house brokerage reduce the costs associated with high frequency trading, it also ensures better execution of trades. Lower commissions and better execution are two things that improve the profit potential of the strategies.

Significant purchases of hardware and software are usually required to successfully implement these strategies. In addition to real-time market data, these costs make active trading somewhat prohibitive for the individual trader, although not entirely impractical.

This is why passive and indexed strategies, which take a buy and hold position, offer lower trading fees and costs, as well as lower taxable events when selling a profitable position. Yet passive strategies cannot beat the market since they hold the general market index. Active traders are looking for “the alpha”, with the expectation that the benefits of trading will outweigh the costs and be a successful long term strategy.

The bottom line

Active traders can employ one or more of the above strategies. However, before deciding to engage in these strategies, the risks and costs associated with each should be considered.

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