Active Trading - Day Trading
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Active Trading - Day Trading

“Money alone sets all the world in motion.” --Pubilius Syrus Maxims, 1st century BC

Day trading refers to the practice of buying and selling financial instruments within the same trading day such that all positions are usually (but not necessarily always) closed before the market close of the trading day. This is different from after-hours trading. Traders that participate in day trading are called day traders.

Some of the more commonly day-traded financial instruments are stocks, stock options, currencies, and a host of futures contracts such as equity index futures, interest rate futures, and commodity futures.

Day trading used to be the preserve of financial firms and professional investors and speculators. Many day traders are bank or investment firm employees working as specialists in equity investment and fund management. However, day trading has become increasingly popular among casual traders due to advances in technology, changes in legislation, and the popularity of the Internet.

Trade Frequency:

Although collectively called day trading, there are many sub-trading styles within day trading. A day trader is actively searching for potential trading setups (that is, any stock or other financial instruments that, in the judgement of the day trader, is ready to move in price with a potential for a substantial profit). Depending on one's trading system (game), strategy, the number of trades the trader can make a day may vary from none to dozens.

Some day traders focus on very short-term trading within the trading day, in which a trade may last seconds to a few minutes. Day traders may buy and sell many times in a trading day and may receive trading fee discounts from the brokerage as a result, as a trading bonus.

Some day traders focus only on price momentum, others on trend patterns, and still others on an unlimited number of strategies they feel are profitable.

Day traders exit positions before the market closes to avoid any and all unmanageable risks --- negative price gaps (differences between the previous day's close and the next day's open price) at the open --- overnight price movements against the position held. Day traders, like all traders, have their rules.

Other traders believe they should let the profits run, so it is acceptable to stay with a position after the market closes.

Day traders often borrow money to trade. This is called margin trading. Since margin interests are typically only charged on overnight balances, there is no cost to the day trader for the margin benefit.

Trading Profit and Risks:

Because of the nature of financial leverage and the rapid returns that are possible, day trading can be either extremely profitable or extremely unprofitable, and high-risk profile traders can generate either huge percentage returns or huge percentage losses. Some day traders manage to earn millions per year solely by day trading.

Because of the high profits (and losses) that day trading makes possible, these traders are sometimes portrayed as "bandits" or "gamblers" by other investors. Some individuals, however, make a consistent living from day trading.

Nevertheless day trading can be very risky, especially if any of the following is present while trading:

  • trading a loser's game/system rather than a game that's at least winnable,
  • trading with poor discipline (ignoring your own day trading strategy, tactics, rules),
  • inadequate risk capital with the accompanying excess stress of having to "survive",
  • incompetent money management (i.e. executing trades poorly).

The common use of buying on margin (using borrowed funds) amplifies gains and losses, such that substantial losses or gains can occur in a very short period of time. In addition, brokers usually allow bigger margins for day traders. Where overnight margins required to hold a stock position are normally 50% of the stock's value, many brokers allow pattern day trader accounts to use levels as low as 25% for intraday purchases. This means a day trader with the legal minimum $25,000 in his account can buy $100,000 worth of stock during the day, as long as half of those positions are exited before the market close. Because of the high risk of margin use, and of other day trading practices, a day trader will often have to exit a losing position very quickly, in order to prevent a greater, unacceptable loss, or even a disastrous loss, much larger than his original investment, or even larger than his total assets.

Trading History

Originally, the most important U.S. stocks were traded on the New York Stock Exchange. A trader would contact a stockbroker, who would relay the order to a specialist on the floor of the NYSE. These specialists would each make markets in only a handful of stocks. The specialist would match the purchaser with another broker's seller; write up physical tickets that, once processed, would effectively transfer the stock; and relay the information back to both brokers. Brokerage commissions were fixed at 1% of the amount of the trade, i.e. to purchase $10,000 worth of stock cost the buyer $100 in commissions.

One of the first steps to make day trading of shares potentially profitable was the change in the commission scheme. In 1975, the United States Securities and Exchange Commission (SEC) made fixed commission rates illegal, giving rise to discount brokers offering much reduced commission rates.

Trading Techniques

The following are several basic strategies by which day traders attempt to make profits. Besides these, some day traders also use contrarian (reverse) strategies (more commonly seen in algorithmic trading) to trade specifically against irrational behavior from day traders using these approaches.

Some of these approaches require shorting stocks instead of buying them normally: the trader borrows stock from his broker and sells the borrowed stock, hoping that the price will fall and he will be able to purchase the shares at a lower price. There are several technical problems with short sales --- the broker may not have shares to lend in a specific issue, some short sales can only be made if the stock price or bid has just risen (known as an "uptick"), and the broker can call for the return of its shares at any time. Some of these restrictions (in particular the uptick rule) don't apply to trades of stocks that are actually shares of an exchange-traded fund (ETF).

The Securities and Exchange Commission removed the uptick requirement for short sales on July 6, 2007.

Trend Following: Trend following, a strategy used in all trading time-frames, assumes that financial instruments which have been rising steadily will continue to rise, and vice versa with falling. The trend follower buys an instrument which has been rising, or short-sells a falling one, in the expectation that the trend will continue.

Contrarian Investing: Contrarian investing is a market timing strategy used in all trading time-frames. It assumes that financial instruments which have been rising steadily will reverse and start to fall, and vice versa with falling. The contrarian trader buys an instrument which has been falling, or short-sells a rising one, in the expectation that the trend will change.

Range Trading: Range trading is a trading style in which stocks are watched that have either been rising off a support price or falling off a resistance price. That is, every time the stock hits a high, it falls back to the low, and vice versa. Such a stock is said to be "trading in a range", which is the opposite of trending. The range trader therefore buys the stock at or near the low price, and sells (and possibly short sells) at the high. A related approach to range trading is looking for moves outside of an established range, called a breakout (price moves up) or a breakdown (price moves down), and assume that once the range has been broken prices will continue in that direction for some time.

Scalping (Trading): Scalping originally referred to spread trading. Scalping is a trading style where small price gaps created by the bid-ask spread are exploited. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds.

Scalping highly liquid instruments for off the floor day traders involves taking quick profits while minimizing risk (loss exposure). It applies technical analysis concepts such as over/under-bought, support and resistance zones as well as trendline, trading channel to enter the market at key points and take quick profits from small moves. The basic idea of scalping is to exploit the inefficiency of the market when volatility increases and the trading range expands.

References

  1. Wikipedia.org



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