Choosing Trading Style in Financial Markets
Day Trading or Position Trading Philosophy?
Jan 25, 2009
Every new trader needs to decide on trading philosophy and make a decision whether to be a day trader or position trader. Some questions to ask are:
- How frequently to trade?
- Will buying and selling occur in the same day?
- Will trading be short term over days or give trades even more time to mature?
These choices must be in accordance with running a trading business and in harmony with the trader’s psychological makeup, comfort level and daily routine. The type of security will also influence this decision: choose a speculative market such as any futures markets or penny stocks, which require close monitoring, or choose to trade blue chips, which can be open for a few minutes or several months.
To help decide, there are two prime market conditions to consider when trading a security: liquidity and volatility.
Market Liquidity and Volatility
Liquidity refers to activity of trades, which in turn is related to volume. For example, high liquidity usually results in a close spread between the bid and ask price. Spread is the difference between the price a seller is asking for a security and the amount the buyer is offering. As this is a favourable condition, it should be considered as part of the initial selection analysis.
Volatility is a measure of the price movement of a security over a given time. A simple measure of the daily price range is needed. Since percentage move is more relevant than an actual price, the simplest index to use is according to:
Volatility = (H – L)/100, where H is the high and L is the low price for the day.
More complicated versions of this indicator have been developed and are available in the literature.
Day Trading
In day trading, the day trader enters and closes his or her trades within the same day. Many trades may take place within the day’s trading session, but the trader has no positions open at the end of the day when trading ceases. Good liquidity and volatility is paramount.
Advantages
- Day trader is not exposed to adverse moves in markets overnight, therefore, gap openings the following day are of no consequences.
- Close stop-loss techniques can be employed for lower risk per trade
- Smaller equity stake can be employed
Disadvantages
- Constant monitoring of market activity is required
- Day trading can be stressful at times
- Total brokerage costs are high due to frequent trading
- Sometimes most profitable trades take time to develop, therefore the day trader will miss out on these moves
Position Trading
A position trader will complete a trade within one to 20 days. Sometimes a trade may exceed this time, perhaps even for a year. Liquidity and volatility are not as critical in position trading.
Advantages
- No need to monitor intraday market movements
- Stops need not be set so close
- Ride price trends which develop over time
- Multiple open positions can be monitored easily
- Dividend payment can be a bonus if trading in shares
Disadvantages
- Susceptibility to adverse news and moves overnight, causing gapping
- Stop-loss settings need to be greater, increasing risk
- Markets can move sideways for extended periods. Therefore, such open positions represent lost opportunities.
Traders need to spend time to consider and decide which trading timeframe to adopt in trading financial markets. The answer depends on the trader’s own psychological profile and involves having an understanding of the speculative, sentiment-driven issues of securities.
The reader may be interested in a related articles, Preparing to Trade in Financial Markets
References:
- "Trading With a Plan", Tony Compton & Eric Kendall, Wrightbooks P/L, Elsternwick, Australia, 2000.
- "Trade Your Way to Financial Freedom", Van K Tharp, McGraw-Hill, NY, 1999
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