Active trading

What active trading is, on the other hand, is a very involved form of stock executions where the investor/broker seeks to profit from the short-term fluctuations in price, exchange, volatility, etc.

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What is Active Trading – Definition and Methods, active trading.

Active trading can be a way to grow your portfolio and focus on generating profits from price movements by speculating on a short-term trend. It is an activity that requires focus and availability of various sources of information to maximize potential opportunities. The active trader is constantly plugged into the stock market, analyzing trends, looking for new opportunities, and constantly ready to make a trade.

What is active trading – definition and methods

What is active trading?

Active traders tend to focus on strategies that are news driven and involve a higher than usual trading volume as it offers increase liquidity. Traders who actively participate in the market establish various methods to accomplish their different active trading goals and most successful traders develop a playbook of strategies that they learn well and practice to perfection. In summary, it is essential to understand the appropriate market environments and risks involved in using all the trading strategies.

Active trading vs passive trading

For active trading to be explained, it can be helpful to understand what differentiates it from passive trading. When one trades passively, you are focused on the long-term investment and growth of an asset. This type of trade involves carefully crafted long-term strategies with the goal of lowering risk. Many get into this type of stock investment to boost their retirement, as a well-diversified portfolio will likely produce a steady return with exponential growth over a wide time frame.

What active trading is, on the other hand, is a very involved form of stock executions where the investor/broker seeks to profit from the short-term fluctuations in price, exchange, volatility, etc.

Types of active trading

Day trading

When people think about what is active trading, they usually think about day trading. This can be explained because day trading involves the buying and selling of stock throughout a single day to take advantage of small market changes. Those who participate in this type of trade are usually professional traders who know exactly what markets to buy into and what times of the day are best for selling. Day trading usually happens online using professional software that offers actionable insights with real-time data as well as historical backlogs. Day trading comes with high risk. Please see our disclosures link to ensure you understand the risks.

Scalping

Similar to day trading, scalping is also a very fast type of active trading. With this method, traders exploit price gaps caused by order flows and bid/ask price spread. What scalping traders try to accomplish is to buy stock at the bid price and then sell it at the asking price quickly for a profit. Many times, trades last less than 5 minutes. As already explained, this is a short-term exchange strategy and traders need to have a strict exit strategy with clearly defined goals. Centerpoint does not accommodate such a strategy.

Position trading

Position trading slightly differs from the other two types of active trading explained so far, in the sense that traders may hold on to stock for a longer period of time. With position trading, stockholders use long-term charts and historical data to determine market trends. Depending on the direction of the market, this type of trade could last up to several days, weeks, and even months. For this reason, some don’t consider it active at all, but rather a passive buy-and-hold strategy.

What happens with this method depends entirely on market trends—as explained by the fact that position trading is less common during high market volatility, but rather traders try to ride “waves” and exit the position along with the trend.

Swing trading

Finally, swing trading is another form of active trading that occurs when trends end. What swing traders try to do is enter the market during the volatile period after one trend ends and another tries to establish itself. Investors usually use an algorithm to determine what stocks to choose and when to sell, but usually they hold on to the stock for a few days but not as long as a trend trade. Those who participate in swing trading are most at risk when the market remains range-bound or sideways.

Develop a strategic active trading strategy today

Now that you know what active trading is, it’s time to start thinking about the tools and strategies that you need to stay competitive. Active trading requires you to have the latest insights on market cycles and trends so that you can easily identify opportunities that are available and capitalize on them.

At centerpoint, we do not endorse or specifically recommend any of these strategies. We do offer top rated customer support from knowledgeable team members that can provide information on professional grade trading platforms and execution services. Contact us today to learn more about our offerings for the active trader.

Active trading

What is active trading?

Active trading refers to buying and selling securities for quick profit based on short-term movements in price. The intention is to hold the position for only a short amount of time. There is no precise time measurement for active trading. Day traders that make tens or hundreds of trades per day would be very actively trading, while a swing trader that is opening or closing positions every few days may be considered by many to be an active trader as well.

Key takeaways

Active trading is attempting to profit from short-term price fluctuations.

Active traders have the intent of only holding trades for a short period of time.

Day traders, scalpers, and swing traders are all considered active traders, with scalpers and day traders being more active than swing traders.

Understanding active trading

Active trading seeks to profit from price movements in highly liquid markets. For this reason, active traders generally focus on stocks, foreign currency trades, futures, and options with lots of volume which allows them to get into and out of positions with ease.

Active traders typically use a high volume of trades to make profits, since the price swings likely to occur over the short term tend to be relatively small. They will also use a variety of order types depending on the situation. To capture a breakout they may use a stop order. For example, if there is resistance at $50, they may set a buy stop order at $50.05, which sends an order to buy if the price breaks through $50 and reaches $50.05.

A stop-loss order—a stop order used to limit losses—helps keep losses manageable if the price moves against the trader.

To capture a favorable price the active trader may use limit orders. If a stock is trading at $30, but a trader wants to see if they can buy at $29.50 on a quick drop, they could place a limit buy order at $29.50. Similarly, they could place a limit sell order to exit the position at $31.

Such orders allow the active trader to buy and sell without having to watch the price every second of the day. They set their orders and know that if the price reaches those levels their orders will trigger.

Since active traders trade within short periods time, fundamental or economic aspects typically don't play a role in the trades. Rather, technical and statistical analysis play a bigger role, with many active traders trading based off of price action or technical indicators or concepts.

Active trading strategies

Active traders typically fall within three categories. Traders in each category tend to trade different amounts and on different time frames, even though they are all short-term traders.

Day trading involves buying and selling a security within the same trading day, usually in an attempt to take advantage of a specific event expected to influence the stock’s price. For example, a day trader may trade the volatile price action that follows a company’s earnings announcement or a change in interest rates made by a central bank. These traders will typically use one, five, or fifteen-minute charts.

Scalping uses a high volume of trades to take advantage of small price discrepancies over the very short term. For example, traders might use the significant leverage available from a foreign exchange broker to amplify profits from tiny movements in price based upon tick charts and one-minute charts. Many automated and quantitative trading strategies fall within the scalping category.

Swing trading involves positions held for a period of several days to several weeks. The swing trader is taking advantage of price moves that occur on hourly, four-hour, and/or daily price charts.

Active trading compared to active investing

While they sound similar, active trading and active investing describe different market approaches. Active investing refers to activities entered into by investors or fund managers seeking to rearrange a portfolio of securities. Active investors constantly seek alpha, which is the difference between a return on an actively managed portfolio compared to an index, benchmark, or similar passive investing strategy.

Proponents of passive investing, the opposite of active investing, frequently cite that active traders rarely outperforming passive index funds. This is primarily due to the increased commissions and costs of active trading. That said, many traders do routinely outperform the indexes, which is why active trading has such an appeal because of its potential for high returns (and higher risk).

Active trading is shorter-term than active investing. While an investor may be active, they often intend to hold positions for years. Active traders are interested in much shorter-term trades.

Example of active trading on a one-minute chart

Active traders use loads of different strategies. Even amongst day traders, it's unlikely that any two will trade exactly the same. The following chart shows how a price-action based day trader may trade a one-minute chart of the SPDR S&P 500 (SPY).

In the example, the trader is watching for trends to develop. In the case of a downtrend: lower swing highs and lower swing lows. In the case of an uptrend: higher swing highs and higher swing lows.

They wait for consolidations and then strong shifts back in the trending direction. They exit with a loss if the price reverses against them. They exit with a profit when the price consolidates again, or when the price starts to move aggressively against the trend direction for at least one minute. Arrows mark trades in the arrow direction, while the "x" marks the exit for the trade.

active trading in SPY based on price action strategy

In a three-hour span, seven trades were opened and closed, for a total of 14 transactions.

The first trade was a winner, the second a loser, the third a winner, the fourth a small profit, the fifth a small loss, and sixth and seventh were both winners. The active trader, like any trader, is simply trying to make more than they lose on the trades they take, overall. Since commissions and fees can add up quickly when actively trading, winnings must be enough to overcome these costs.

The strategy discussed is for demonstration purposes only.

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Buy and hold vs. Active trading

There are pros and cons to each style of investing.

When getting started with the stock market, you'll probably notice most investors fall into one of two camps. One side says you are better off buying stocks and holding them for a very long time without worrying about the short term. But others prefer taking an active approach to their portfolios. These investors regularly buy and sell various stocks with a focus on earning more without waiting around.

You'll probably find some mix of the two works best for your investment goals. But before you click that button to enter an order, you should take the time to learn about both approaches. Once you understand how “buy and hold” and “active trading” work, you can build a strategy that aligns with your risk tolerance and investment objectives.

What is a buy and hold strategy?

A “buy and hold” approach to your investments works, as the name implies. Investors with this preference tend to buy stocks (or other investments) to hold for many years. Sometimes these investors will hold an investment for decades.

Buy and hold strategies are based on the premise that the markets tend to rise in the long term. If you buy a good portfolio of stocks or funds and just leave them alone, the value should steadily increase.

Research shows that timing the markets is very difficult, if possible at all. If investors do a proper fundamental analysis of each investment and the underlying business continues to perform well, it should be a slow and steady march to capital gains.

But you can't buy and hold just any stock and expect it to perform well. You should still make a point to do a good analysis on each investment and understand why you own it. No matter what strategy you use to invest, never invest in a stock or other investment that you don't understand.

Over any long period of time, the S&P 500 has offered around 10% annual returns. This is why warren buffett is an evangelist of this type of long-term investing. For evidence of how many people believe in this investment style, just look at the swelling values of large, low-fee index funds from providers like E*TRADE, merrill edge, ishares and others.

What is an active trading strategy?

But some people prefer more excitement in their portfolios. A large number of market participants are interested in capturing value from shorter-term changes in stock prices. These active investors look at company fundamentals but put a big emphasis on technical analysis.

Technical analysis is the use of charts and recent market volatility to find patterns. These patterns can be indications that a stock is about to go up or down. While some people find high levels of success in this area, it is considered quite risky by many investors.

In fact, benjamin graham, author of the intelligent investor, says that this is not actually investing. He says it's speculation. And his book is one of the most popular investment books of all time.

Active trading vs day trading

It is important to make a distinction between active trading and day trading. Active trading means buying and selling stocks to earn on short-term price changes. Day trading is doing this at a hyper-fast speed, typically buying a stock and selling again within just a few minutes or hours. Day trading is considered incredibly risky, even more so than other forms of active trading.

While active investing has many fans, the numbers say that even most professional active fund managers can't beat the markets consistently. If someone who gets paid to do it for a living can't beat the markets, can you?

If you're interested in active trading, you can do so through discount broker public.Com. You can buy and sell stocks without paying any commissions. Their platform is very easy to use, which makes it a great option if you're just getting started with active trading and find other platforms intimidating.

Weighing the pros and cons

The numbers clearly favor a buy-and-hold approach over an active trading approach. Even if you have a finance education from one of the best universities in the U.S. And spend your entire workday analyzing stocks, you probably won't beat the market. Most of us don't have that education or that much time. That's why buy and hold is most often the best choice.

But in reality, most investors fall somewhere in the middle. I have purchased stocks with plans to keep them for years but based on changes in the markets or the underlying company — or even my own financial plans — have sold earlier. And in other cases, some stocks have been in my account for the better part of a decade, and I don't have any plans to sell.

But even passive investors need to keep tabs on their portfolio. If you decide to buy and sell individual stocks, take the time to read annual reports, follow quarterly earnings releases and stay in tune with your portfolio.

Deciding on the best strategy for you

If you are risk-averse and your primary concern is capital preservation and long-term profits, a buy and hold strategy is probably your best choice. If you are okay with more risk and volatility and are willing to put in the time every day to manage your investments, an active trading strategy could work.

Most people are better off avoiding active trading, but it does work for some people. By understanding your goals, risk tolerance, abilities, and limitations, you can decide on the right mix for your finances. Are you ready to get into the stock market? Read our guide.

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Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read characteristics and risks of standardized options. Supporting documentation for any claims, if applicable, will be furnished upon request.

Sell orders are subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal).

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Active trading: all hype, no substance

What is active trading? Is active trading based on speculation or investment?

Active trading is when you trade often and without research. Brokerage firms often promote active trading as a way to get rich quickly, but this won’t happen for real, smart investments.

Read more about active trading and how it can affect your wealth.

Don’t believe the active trading hype

So what is active trading? You’ve likely seen commercials for stock brokerages that let you trade more conveniently and with lower fees than ever before. Beware: brokerages make money when you trade, and not when you make money. Therefore, brokerages hype up speculation for common investors in their marketing, promising riches at unprecedented speed.

(shortform note: with the advent of mobile apps for trading and zero-commission trading, the barrier to trading is lower than ever. How do brokerages with zero commissions make money through trading? By selling order flow to market makers, who profit from inexperienced investors.)

As a result of these tools, trading activity has increased dramatically, as well as impatience—in 1973, a shareholder kept a stock for 5 years before selling it; by 2002, that shrunk over 80%, to 11 months. During frenzied periods, like the dotcom bubble in 1999, a share might be held an average of a few days.

Beyond just making poor investment decisions, active trading has other punishing drawbacks:

A frenetic speculator who is desperate to buy or sell a stock may accept unfavorable prices for the sake of speed. For instance, someone who wants to trade 1,000 shares of a stock and misprices by 20 cents per share gives up $200.

If you hold a stock for less than a year, any gains on that stock are taxed at ordinary income rates, rather than the lower long-term capital gains rate.

(shortform note: recent research suggests that individual active traders even tend to earn below-market returns before accounting for fees—individual investors simply trade stocks poorly.)

Thus, accounting for small losses and taxes, an active trader might need to gain at least 5% just to break even.

A 2000 study by finance professors found that the most active traders (who turned over more than 20% of their holdings each month) underperformed the market by 6.4% per year, while the least active traders (trading less than 0.2% of holdings each month) matched the market.

The message is clear: “active trading is hazardous to your wealth.

Speculation disguised as investment

In addition to trading based on market movements, graham cautions against these common methods of speculation that masquerade as investment:

Trading based on short-term earnings reports: estimating future earnings accurately is already difficult in itself. But studying earnings is so common and competitive, with legions of analysts on wall street, that even if you get it right, the stock price probably already reflects those earnings.

Trading based on long-term growth prospects: here you may have a more optimistic view of certain companies than the overall market. But graham is once again skeptical that an individual investor has the insight and vision needed to consistently outperform the market on these predictions.

In his commentary, zweig shares examples of popular formulas that failed to perform:

The “january effect”: A strategy published in the 1980s that claimed that small stocks dip at the end of the year and rise at the beginning of the year. The explanation is that investors sell their worst stocks by the end of the year to reduce taxes; investment firms also sell falling stocks by year-end to make their annual performance look better. The january effect looked strong up until the 1980s, after which it began disappearing.

In 1996, a money manager named james O’shaughnessy published a simple strategy in his book what works on wall street: buy 50 stocks with the highest one-year returns, 5 years of rising earnings, and share prices less than 1.5x revenues. He created funds based around this strategy, but they underperformed the S&P 500 through 2000, and some of those funds promptly shut down.

The motley fool’s “foolish four”: take the five stocks in the dow jones with the lowest price and highest dividend yields; discard the one with the lowest price; invest 40% in the stock with the second-lowest price, and put 20% in the other three. Repeat each year. When published, the technique claimed to produce a 10.1% annual return above market in a back-test over 25 years. But when applied going forward, this failed to perform any better than random stock picking.

Strategies that seem to work when back-tested against historical data may be illusory. If you look for enough patterns, you will find some that seem to work, by mere chance, but they will fail to deliver consistent performance over time.

Even if the strategy really does work, if it becomes popular, the competitive market will adopt the strategy, thus erasing its possibility for profit. We’ll discuss this more in the last section of the chapter.

Any simplistic strategy that mechanically picks stocks, without thorough consideration of the company’s underlying value, does not qualify as investment under graham’s definition.

Speculation isn’t immoral or necessarily bad for society. Speculation based on the promise of future growth fuels innovation—new upstarts like google or amazon needed optimistic speculators to provide capital. But for most people, speculation is a poor way to attain wealth.

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