Active Trading - Explained
What is Active Trading?
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Table of ContentsWhat is Active Trading?How Does Active Trading Work?Active Trading StrategiesActive Trading Compared to Active InvestingAcademic Research on Active Trading
What is Active Trading?
Active trading is the purchase and sale of securities for fast profit on the basis of short-term price movements.
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How Does Active Trading Work?
Active trading seeks profit from price movements in markets of high liquidity. Because of this, active traders usually focus on foreign currency trades, derivatives, or volatile stocks. Active trading needs a more speculative viewpoint that strategies of buy and hold. This makes technical analysis a beneficial tool for active traders with its predictive techniques based on the price charts of equity. Usually, a high volume of trades is utilized by active traders for profit-making, since price swings which may happen over the short-term tend to be small. Active traders also frequently use limit orders, which make it possible for traders to set exact price levels at which securities can be sold. Stop-loss orders, for instance, utilize a lower price point to limit a trade's downside, ensuring maximum loss supposing the price's movement goes against the trader. An upper limit is set to the price by take-profit orders. This might limit upside in cases where the price goes up unexpectedly, but this makes it possible for traders to lock in a specific amount of profit without monitoring price movements closely in a bid to sell precisely at the right time.
Active Trading Strategies
Active traders have various strategies in their arsenal depending on how long they intend holding a security. Day trading refers to the purchase and sale of a security within the same day of trading, in order to capitalize on a particular event expected to affect the stock's price. For instance, an investor might foretell short-term price movements based on the earnings announcement of a company or an announcement of the central bank's change in interest rate targets. Swing trading involves holding positions for several days. In situations such as these, investors expect price movement to range from a day to two weeks after entering a trade. Scalping utilizes high trade volumes to capitalize on little price discrepancies over the short-term. For instance, traders may utilize the major leverage available from a foreign exchange platform in order to increase profits from small price movements based on both one-minute charts and tick charts.
Active Trading Compared to Active Investing
While these two terms sound familiar, active investing and active trading describe strategies that are entirely different. Active investing are activities which are entered into by fund managers or investors who want to rearrange securities' portfolios. Active investors consistently seek alpha, which differentiates the return on an actively managed portfolio from that of a benchmark, index, or a passive investing strategy that's similar. Passive investing proponents often state how difficult it can be for an active portfolio's profits to overcome the additional expenses incurred by active investors. For this reason, most inexperienced investors would probably see more returns from index funds, as well as, similar products.