What is Active Trading
Active trading refers to buying and selling securities for quick profit based on short-term movements in price.
BREAKING DOWN Active Trading
Active trading seeks profit from price movements in highly liquid markets. For this reason, active traders generally focus on volatile stocks, foreign currency trades, or derivatives. Active trading requires a more speculative outlook than buy-and-holdstrategies. This makes technical analysis, with its predictive methods based upon an equity’s price charts, an attractive tool for active traders.
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. Active traders also make frequent use of limit orders, which allow traders to set specific price levels at which to sell securities. Stop-loss orders, for example, use a lower price point to limit downside on a trade, ensuring a maximum loss if the price moves against the trader. Take-profit orders set an upper limit to the price. This may limit upside in scenarios where prices rise unexpectedly high, but it also allows traders to lock in a certain amount of profit without having to watch price movements closely in order to sell at exactly the right time.
Active Trading Strategies
Active traders have a range of strategies at their disposal depending upon the length of time they wish to hold a security:
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, an investor may predict short-term price movements based on a company’s earnings announcement or an announcement of a change in interest rate targets made by a central bank.
Swing trading involves positions held for a period of several days. In these cases, investors expect prices to move sometime between a day and two weeks after they make a trade.
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 trading platform to amplify profits from tiny movements in price based upon tick charts and one-minute charts.
Active Trading Compared to Active Investing
While they sound similar, active trading and active investing describe completely different strategies. Active investing refers to activities entered into by investors or fund managers seeking to rearrange portfolios 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 frequently cite the difficulty an active portfolio’s profits can have overcoming the extra expenses incurred by active investors as a reason most inexperienced investors will likely see better returns from index funds and similar products.