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What Is Active Trading?
Active trading involves purchasing and selling securities based on short-term price movements to earn quick financial gains. Traders can utilize this type of trading strategy to beat the benchmark indexâs performance and achieve their financial objectives.
Besides allowing individuals to earn high returns, this strategy offers traders and portfolio managers flexibility. They can buy and sell financial instruments based on the market scenario to maximize returns. Some popular active trading strategies for short-term financial gains are scalping, position trading, swing trading, and day trading.
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- Individuals earn profits from active trading and speculation by taking advantage of short-term price movements in highly liquid markets.
- Traders want to fulfill the objective of outperforming the benchmark index by using active trading method.
- Some of the most popular active trading methods are scalping, swing trading, and day trading. One should pick a strategy after weighing the pros and cons of each method.
- This trading method provides individuals with flexibility as they can buy or sell financial instruments after considering the market scenario.
Active Trading Explained
Active trading refers to buying and selling financial instruments to earn gains based on short-term price movements in highly liquid markets. Individuals who aim to generate profits from active trading and speculation purchase and sell securities, such as stocks and derivatives, with high trading volume as the price swings over the short term, are usually small. They also place different types of orders based on the situation.
For example, one can place a stop-loss order to sell a stock once its price reaches a certain level. This limits a traderâs downside risk. On the other hand, traders can place a take-profit order to book a certain profit without closely tracking the price movements.
Besides conducting thorough research and analysis regarding the financial markets, active traders use technical analysis to identify trends, make predictions, and select the right trading strategy.
Strategies
One must select the right method based on the market scenario to earn profits from active trading and speculation.
Let us take a look at some of the most popular strategies that traders can consider choosing.
1. Position Trading
Position trading involves using long-term charts, market data, and other strategies to determine market trends. The duration of the trade, when carried out using this strategy, depends on the direction of the market. It could last for up to many days, weeks, or months. This is the reason many traders consider this to be a buy-and-hold strategy.
A trend trader looks for consecutive lower highs or higher highs to determine a financial instrumentâs trend. They try to benefit from the upside and downside movements by riding the âwaveâ and exiting their position when the tread breaks. Hence, implementing the position trading strategy is extremely challenging in periods of high volatility.
2. Scalping
This method is one of the fastest active trading strategies used by traders. It involves identifying and taking advantage of bid-ask spreads that are narrower or wider than normal. Unusual bid-ask spreads may arise due to supply-demand imbalance. Traders use this strategy to purchase a stock at the bid price and then sell it quickly at the ask price to make a profit.
Trades using the scalping strategy usually last below 5 minutes. One does not need to have a clearly defined exit strategy and predetermined goals to succeed using this strategy. In the case of scalping, the profit earned per trade is low. Hence, individuals opting for this strategy try to increase the number of trades.
3. Swing Trading
Swing trading involves taking a position in a security for more than a day. The traders may even have to hold their position for several weeks to make a profit. They enter a trade when a trend ends, and a new one begins. At that time, the financial instrumentâs price is subject to volatility. Swing traders may hold their position for several days, but the duration is less than a trend trade. When implementing this strategy, traders often create a set of rules for themselves based on fundamental and technical analysis.
They design the rules or algorithms to decide when to purchase and sell a financial instrument. The risk increases for swing traders in a sideways or range-bound market.
4. Day Trading
As the name suggests, day trading refers to buying and selling securities within a single day to profit from the price fluctuations. In other words, when traders opt for this strategy, they enter and exit a position on the same day. They do not hold their position overnight.
Usually, experienced traders opt for day trading as one requires the knowledge and expertise to know the right time to buy or sell a security. However, this is a high-risk strategy. Hence, investors know the associated risk factors before choosing this trading method.
Examples
Let us take a look at a few active trading examples to understand the concept better.
Example #1
AXS Investments launched 8 single-stock leveraged exchange-traded funds (ETFs) out of the 20 that have received the green light. These funds aim to make short-term single-stock investments more popular among investors. They are specifically for individuals who use active trading strategies to make quick financial gains.
AXSâs new offerings are equity-based; the stocks are actively bought and sold in the market; they include sector behemoths like PayPal, Tesla, Pfizer, etc.
Example #2
Suppose an investor Jim purchases 100 shares of company ABC when the market opens at $5 per share. After 3 hours, the price of the stock starts surging. Jim decides to sell his holdings at $6.1 per share, thus making a total profit of $110.
Active Trading vs Passive Trading
The two approaches often spark a debate among portfolio managers and traders as they prefer one over another. Individuals who are new to trading must know about their differences before choosing a strategy. One can refer to the following table on active trading vs passive trading to get a clear idea regarding these two trading methods:
| Basis of Comparison | Active Trading | Passive Trading |
|---|---|---|
| Purpose | This strategy aims to outperform the benchmark index. | The primary objective of this method is to match the returns of a benchmark index. |
| Flexibility | This strategy is much more flexible as traders can buy or sell securities based on the current market scenario. | This strategy is less flexible as traders and portfolio managers are not actively involved in the buy-and-sell decisions. |
| Cost | Portfolio managers who use this strategy levy a high fund management fee as they have to conduct thorough research and analysis. | Portfolio managers impose a lower fee as they only track the benchmark index. |
| Ideal for | Individuals who have adequate time to monitor the performance of the market. | Traders who do not have sufficient time to track the market. |
Frequently Asked Questions (FAQs)
If individuals trade with leverage, they can take a greater position in a financial instrument without paying the full investment amount. This could be beneficial as it increases the purchasing power of traders who do not have much money.
Individuals can follow these steps to start trading using this strategy:.
1. Select a broker and open a brokerage account.
2. Set budget for securities trading.
3. Learn to use the different types of orders.
4. Identify and buy the right stocks
5. Build positions slowly to minimize risk.
6. Measure the performance against the right benchmark index.
There is no right or wrong option. Instead, the choice of strategy depends on an investorâs financial goals, investment time horizon, and risk appetite.
Active trading can be worth it if investors buy and sell securities judiciously and make the most of short-term price movements.
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This has been a guide to Active Trading and its meaning. Here we discuss types of active trading strategies with examples and differences with passive trading. You can learn more from the following articles -
