There are five main types of trading available to technical traders: scalping, day trading, momentum trading, swing trading and position trading. Mastering one style of trading is very important, but the trader also needs to be proficient in others. If in doubt, stay out of the market. Standing aside is considered a defensive position, and there’s nothing wrong with waiting for an opportunity.
Scalping (or micro-trading) is all about taking very small profits, repeatedly. Typically, trades last from seconds to minutes. Scalping is a trading strategy that attempts to make many profits on small price changes. Traders who implement this strategy will place anywhere from 10 to a few hundred trades in a single day in the belief that small moves in stock prices are easier to catch than large ones.
Scalping is an expert skill and, although many people find the idea attractive (and exciting for adrenaline junkies), I wouldn’t recommend it for beginners.
Day trading is all about buying and selling on the same day, without holding positions overnight. Compared to scalping, this style calls for holding positions for minutes to hours versus seconds to minutes. A day trader closes out all trades before the market closes. Most day traders use leverage to magnify the returns generated from small price movements.
Day trading is often glamorised as an easy way to get rich quickly. However, this is rarely the case. Day traders typically suffer severe financial losses in their first months of trading and many never graduate to profit-making status. Day traders are handicapped by the bid-ask spread, trading commissions and other expenses. These costs require day traders to earn significant trading profits just to break even.
Both scalping and day trading require strong discipline; the time and ability to learn how to trade a tested and profitable strategy rapidly; and enough capital to withstand sudden and, possibly, larger-than-expected losses.
Both scalping and day trading are what is known as intraday trading. If you buy and sell shares in a single day, then you are considered to have traded intraday. An intraday trader opens (buys) and closes (sells) their trades (also called positions) within the trading day, leaving no trades open overnight.
In momentum trading, the trader identifies a stock that is “breaking out” and jumps on to capture as much of the momentum on the way up or down as possible. They focus on stocks that are moving significantly in one direction on high volume. The typical time frame for momentum trading is several hours to several days, depending on how quickly the stock moves and when it changes direction.
Swing trading is the art of capturing the short-term trend. It is a style of trading that attempts to capture gains in a stock within one to seven days. Swing traders use technical analysis to look for stocks with short-term price momentum. These traders are not interested in the fundamentals or the intrinsic value of stocks, but rather in their price trends and patterns.
In my opinion, swing trading and position trading are the only two types of trading in which a person with a full-time job can still consistently trade well part-time. Since the holding period is several days, intraday moves will not affect the swing trader as much as they would a day trader. A typical holding period for a swing trade is three to seven days.
Position traders stay in trades for weeks to months. The position trader endeavours to anticipate whether the current trend will continue for a much longer term than a momentum or swing trade. Position trading gives traders who cannot trade frequently a lot of freedom: profit potential is not diminished and position traders can make considerable gains. Long-term traders are not concerned with short-term fluctuations, because they believe that their long-term investment horizons will smooth these out. Position trading is the polar opposite of day trading, because the goal is to profit from the move in the primary trend, rather than the short-term fluctuations that occur from day to day.
None of these types of trading are limited to buying. With certain types of instruments, the trader can also short (or short-sell) the stock. This means that profits can be made in both rising and falling markets.
When choosing a trading type to suit your needs, here are some questions to ask:
- Am I short-term- or long-term-orientated?
- How much time do I have during the day to trade?
- Do I work full-time?
- Am I patient, or do I need to see results quickly?
Ross Larter is CEO of Sure Trading, a stock market education company. This is an edited extract from his new book, How To Make Money On The Stock Exchange.
This article originally appeared in the 2 February edition of finweek. Buy and download the magazine here.