Active Trading

DEFINITION of 'Active Trading'

Actice trading is the  buying and selling of securities with the intent of holding them for a short duration, usually no longer than one day. Active trading as an investment strategy seeks to take advantage of short-term price movements with a focus on highly liquid markets like stocks, currencies, options, and derivatives. Active trading is considered one of the most speculative trading strategies.

BREAKING DOWN 'Active Trading'

Active trading is the buying and selling of securities within days or weeks to capitalize on short-term price movements. In general, active traders use various forms of technical analysis to identify buy and sell signals, as well as set stop-loss and take-profit points.

Active trading shouldn’t be confused with active investing, which involves picking stocks for long-term portfolios based on fundamental analysis. In contrast, active traders focus exclusively on finding short-term trades using technical analysis.

The primary benefit of active trading is that it generates a consistent income with greater upside potential than long-term passive investing. In fact, most active traders use leverage to amplify their capital and enhance the earning potential of their positions. Traders may also specialize in specific assets, such as stock options or futures.

The primary drawback is that academic studies conducted by Terrance Odean and Brad Barber found a positive correlation between trading activity and negative returns. In other words, the researchers found that those trading more often tended to generate worse returns. High frequency trading has also made it difficult for active traders to compete in some markets.

Active Trading Strategies

Active traders use several different strategies to identify and capitalize on opportunities over the course of a single day to several weeks using technical analysis. These strategies may be implemented manually or automated using trading systems.

Popular active trading strategies include:

  • Day trading is the buying and selling of securities in the same day based on technical factors or simple supply and demand. For instance, a day trader may short sell – or fade – a stock following an earnings announcement run-up.
  • Swing trading takes advantage of short-term price swings that last several days as opposed to a single day. For example, a swing trader may predict that a stock is about to break out and decide to take a position a day or two beforehand.
  • Position trading looks at longer-term technical opportunities that may arise over the course of a week to several months. For example, a trader may see a long-term ascending triangle chart pattern with favorable underlying fundamentals and decide to take a position in the stock that may require a couple weeks to materialize.
  • Scalping is a fast-paced strategy that involves making hundreds of trades per day to take advantage of small price discrepancies. For example, scalpers may take advantage of ECN rebates to buy and sell for a marginal profit with each trade.

The Bottom Line

Active trading is the buying and selling securities within days or weeks to capitalize on short-term price movements. Active traders use many different strategies to generate buying and selling signals, including day trading, position trading, swing trading, and scalping. There are many benefits and drawbacks to active trading, but some academic research suggests that active traders face an uphill battle for returns.