Sunday, July 11, 2010

3 ways to play the market

During my many years in the trading and trading education world, I have been a day trader, swing trader, and longer term position trader. While my strategy has never changed, the time horizon for finding opportunities and holding positions has changed a bit over my career. The focus of this piece is to explain the differences between day, swing, and position trading, and also explore the advantages and disadvantages of these different styles.

Day Trading:

Day trading is typically described as the action of entering a position in the market with the intention of exiting that position before the close of the trading session, that day. Day trading requires fast connection speeds, powerful computers, back-up systems, real time data, direct access execution systems, and multiple monitors.

The positives: For those with high energy, looking for action each day, yet also have very good discipline, day trading is for you. In general, profitable day traders are not the ones taking 10-100 trades a day.

The consistently profitable day traders are the ones who tend to take the 1-3 quality opportunities offered to them, typically near the open of the trading session.
Those who are very good at making key decisions on the fly can do well here. Day trading also allows traders to take advantage of the many short-term supply and demand imbalances in the markets each day.

The negatives: For many, day trading is attractive due to the “get rich quick” mindset. While some will do very well in a short period of time, many end up losing money in this venture. Emotions tend to run very high when day trading, making rule-based execution difficult for those who have any issues with discipline. There is also the added difficulty of competing with market makers at the day trading level.
Lastly, day trading is the most time-consuming style of trading as it requires you to be in front of your computer screens each day while you're trading.
Those who are not good at making quick decisions are not likely to succeed at day trading.

Swing Trading:
Swing trading is typically described as the action of entering a position in the market with the intention of holding that position for one day to a couple weeks, or even longer in some cases. Swing trading does not require real time data or direct access execution though it is recommended.

The positives: From my experience, swing trading is where the largest number of aspiring traders succeed. Swing trading captures the market niche with the least amount of competition. It's a timeframe too large for day traders and too small for longer term investors and institutions. Proper swing trading does not require a big time commitment. Spending an hour or so performing your market analysis two or three times a week will suffice. Typically, swing traders will take advantage of today's technology and use the “set it and forget it” approach when entering positions into the market.

It helps take the biggest risk to trading out of the equation, you and your human emotion. Swing trading offers the benefit of pre-planning every part of the trade no matter when you are doing your analysis. In fact, the best time to perform your swing trading analysis is when the market is closed.

The negatives: Swing trading is somewhat boring to the active day trader as opportunities are not present each day. For those swing trading stocks, you will find opportunities come in bunches. For example, when the S&P is in an uptrend and price has temporarily declined to a demand (support) level, most stocks will be set up as buying opportunities at that time. As soon as the S&P rallies from that level, most of the swing trading low risk entries will be gone. This is not necessarily a bad thing, but the waiting game is unattractive to most people in general.

Longer term position:
This style is typically described as the action of entering a position in the market with the intention of holding that position for weeks to months. There is no need for real time data or direct access executions.

The positives: Longer term position trading to most people is “buy and hold.” This may be the best style assuming (and this is important) you buy and hold AT THE RIGHT TIME. This style is very hands-off in that every part of the trade is pre-planned, well in advance. It leaves you plenty of time to enjoy other things in life outside of markets and trading.
The negatives: Many long-term market speculators use news and professional opinions as their primary decision-making tool. Typically, this will lead to buying high and selling low which means losing money. Ideally, price charts, demand, and supply should be your primary set of tools. This style takes time to produce results. Successful trades may take place over a multi-week or month period and some people are not fine with this. Also, this style requires capital to be tied up for longer periods of time than day and swing trading, so opportunity cost may be a concern.

Whatever type of trader you are, keep in mind that your rule-based strategy will not change. A strategy that works in one market or timeframe should work in any market or timeframe. Whether you are day trading on a one minute chart, or taking three trades a year off opportunities found on the weekly chart, the way consistently profitable market speculators derive income is from buying low and selling high, or selling high and buying low. This means you must become proficient in identifying market turning points, which comes down to the ability to objectively quantify demand and supply in any and all markets. Once you can do this, identifying price levels where this simple and straight-forward equation is out of balance is not that difficult and that is where low-risk/high-reward opportunity lies.
As for me, the most profitable and comfortable trading has always been swing trading.

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