Strengths and weaknesses of each type of trading
There are very many types of trading: high-frequency trading, scalping, day trading, swing trading, middle-term trading and long-term investing. Which one to select? The answer will become clear after we will see what each of the trading type is like.
Read in this article:
– Types of trading.
– Advantages and disadvantages.
– Plus one joke about investments.
What trading style to select?
The market is as diverse as the life itself. The most important thing is to establish yourself properly.
If you want to make good money trading on the exchange, it is necessary for your trading style to correspond with with your personal character, circumstances and experiences. If a trader is inclined to use one trading style, the results of his activity in another style would be significantly worse, right down to the negative ones.
It is like doing the work you don’t like. That’s why it is very important for a beginner trader to know his niche in the market and act in ‘his style’. Then the synergy starts to work and trading efficiency will increase.
Types of trading
Trading in the global world of financial markets is divided into types on the basis of the period of time during which a position (trade) is held. Thus, it is divided into 6 generally accepted types (styles):
- High-frequency trading. Trades last for milliseconds.
- Scalping. Positions are held during several seconds or several minutes.
- Day trading. This type of trading is also called intraday trading. As it is clear from its name, all trades are conducted within one trading session. Positions are held not longer than duration of one trading session. An intraday trader goes home without having open positions.
- Swing trading. A position is held longer than one day. Usually, it is held from several days to several months. There are no clear time frames here.
- Middle-term trading. This method is for the traders who catch long fluctuations. Middle-term traders hold their positions during many weeks and months.
- Long-term investing. This type of trading, which is called ‘buy and hold’, best fits the stock market. A bright example is one of the richest people of the planet Warren Buffett.
Let’s analyze each of the trading types (styles) in detail and list advantages and disadvantages. But before doing it we will make a small statement.
Since the boundaries between the trading types are fuzzy and one style smoothly flows into another, advantages and disadvantages of one type relate, to a certain degree, to the neighbouring types. Please, take this into account and do not criticize our list of pros and cons too much.
What is high-frequency trading (HFT)? This is such a type of trading when positions are opened and closed extremely fast.
HF Trading is the robot business since an average time of holding a position is about 100 milliseconds (0.1 second). We wrote about this trading type in the following articles:
- Influence of HFT on trading (official study of the Central Bank of the Russian Federation);
- Spoofing on the exchange;
- Influence of the algorithmic trading on futures.
That is why, if you want to work in this trading style, you need to develop a robot and try to locate it as close to the exchange as possible.
- having created an ideal robot you get a universal mechanism for making money. Apart from a stable cash inflow, you get plenty of free time. It is a fairytale story but remember that a fairytale in real life is an extremely rare thing.
- complexity of the robot programming;
- nuances in testing and optimisation;
- a HFT robot needs special conditions – maximally fast and seamless access to the exchange and stable energy supply. Delays in milliseconds could become fatal;
- frequent trades result in big commissions. That is why not all the markets are good for HFT. You need to select only liquid instruments with minimal expenditures. And, preferably, such conditions, under which market-makers trade;
- it often happens that a HFT robot loses its efficiency after some time since the market situation and rules of the game changed.
This trading type already fits human beings. Trades in scalping last for several seconds and, sometimes, for several minutes.
Scalpers (traders that do scalping) adhere to the ‘grain by grain and the hen fills her belly’ principle.
It is highly unlikely that scalpers would be satisfied with the fact that they spend days to sell automobile spare parts or type texts in a small office room. Deep-rooted scalpers prefer to gently fight with the market and other professionals day by day.
Their strategy lies in a big number of small trades. As a result, a day should be closed with a positive result. Scalpers catch small impulses caused by different factors. If you like the extreme situation feelings, then the scalping fits you. Splashes of adrenaline from fast trading is an important factor in your decision to make a living by scalping.
As a rule, the working space of a scalper (a real example is in the picture below) are inhabited by the Smart Tape modules, different variations of the Smart DOM and cluster charts with the time-frames from 1 second to 3-5 minutes.
Scalping is interesting for beginner traders due to the fact that a frequent execution of trades helps to:
- quickly work out experience;
- intensively study the market mechanics and chart patterns;
- train the trader’s psychology.
- you do not need to have a big start-up deposit – USD 100-200 is enough for 1 contract scalping on the Moscow Exchange;
- a multiple circulation of the working capital provides a potential for increasing the deposit;
- a comparatively simple development of a trading plan, since the scalping formations are not considered to be complex;
- there are many trading signals during a day even in one market;
- there is no risk of an overnight trade.
- an exhausting style of trading. It is not easy to sit in front of the computer and focus on the course of the trades in order to catch a successful moment of entering a trade. Also, each trade requires attention for monitoring it. That is why scalpers trade during a selected period, for example, 1-2 hours after opening a session;
- focusing on short periods, you may miss the influence of longer time-frames;
- high expenditures caused by frequent trades. The trading profit is often comparable with the commissions paid. That is why the percentage of successful trades should be significant in the scalping strategies;
- high hardware and connection speed requirements;
- it becomes more difficult to work with scalping as you get older.
We recommend you to read the following materials if you want to learn more about practical scalping techniques:
Day trading or intraday trading
Day trading (intraday trading) envisages, as it follows from the name, execution of dozens of trades during one day on the basis of the technical analysis and complex chart systems. The traders of this trading type are called intraday or simply day traders.
The goal of an intraday trader is to make a living by trading stocks and futures, receiving a small profit from multiple trades and strictly limiting losses from unfortunate decisions.
The biggest attraction of the day trading is a potential for an impressive profit. However, not every trader is capable of realizing that potential. A day trader should possess such qualities as decisiveness, discipline and fervour. They are a must for achieving success on a roller-coaster ride during the day.
The US Securities and Exchange Commission (SEC) notes that the day traders, as a rule, bear financial losses during the first months of trading and many of them never acquire the status of profit-making traders.
And although the SEC, trading courses and common sense warn that day traders should put at risk only that money which they can afford to lose, the reality is such that they make huge losses using the borrowed funds or by means of margin trades or due to ‘borrowing’ from the family budget or other sources. These losses may not only destroy the day trading career, but also result in personal problems.
Advantages of intraday trading:
- A day trader works alone during the day independent of the whims of his bosses. He may have a flexible schedule of work, have rest as required and work in his own rhythm, unlike a hired worker.
- Availability of a certain degree in a certain university is mandatory only for a job interview for many job positions in the field of finance. The day trading, on the contrary, doesn’t require expensive higher education. You can find many free educational materials on the Internet, however, of doubtful quality. We recommend you our videos and articles, which are really directed at the growth of real knowledge about the market.
- All positions should be closed by the end of the day and not a single position should be left overnight if it is intraday trading. A trader can have a sound sleep at night since there is no risk whatever.
- You can gain experience during a short period of intraday trading. Intraday traders usually execute 10 trades every day. It is less than scalpers, but, in fact, a trader gains knowledge and develops his mastery every day.
Although this type of trading is the most attractive one, the majority of people who trade exchange instruments on the intraday basis cannot make money. Insufficient training and discipline, as a rule, result in their failure.
Nevertheless, it could become a profitable enterprise for those who are ready to do homework, develop own trading plan and strictly stick to it.
- Full-time occupation. In order to try to become an intraday trader, you need to retire from your day job and forget about your regular monthly salary. From this moment, a day trader becomes completely dependent on his own mastery and efforts in order to make a profit, pay the bills and have a decent life. Trading under the pressure of responsibility is not a favourable factor.
- Day traders have to compete with robots, hedge funds and many market professionals who spend millions for receiving trading advantages. An intraday trader often has the only choice in such an environment – to increase his competitiveness by means of advanced software for analyzing and trading.
- Similarly to scalping, day trading is stressful due to a necessity to monitor several screens searching for opportunities and then to act quickly in order to use them. This has to be done day after day and a need in such a high degree of concentration and efforts may often result in burnout.
- High dependence on commissions. For example, an active intraday trader with a USD 20,000 deposit who works with e-mini S&P contracts may well accumulate a total commission in the amount of USD 5,000-10,000 by the end of the year.
- Insufficient training and discipline, as a rule, could result in losses. Day trading could be unforgiving. Nevertheless, the day trading could be a profitable enterprise for those who are ready to develop both themselves and a trading plan and strictly stick to it.
Swing trading is based on the analysis of fluctuations in stocks, commodities and currencies, which last for several days. A trade of a swing trader may take up to several months. Unlike an intraday trader, a swing trader would hardly allocate his whole working time to trading.
Anybody who has ideas and investment capital could try swing trading. Due to a longer time-frame (1 hour, 4 hours, 1 day, etc.), a swing trader doesn’t have to stick to the computer monitor the whole day long. He even can completely concentrate on another type of activity.
- Keeping an open position during several days or weeks could result in a higher profit than trading the same security several times a day.
- Since the swing trading is rarely a full-time occupation, a probability of over-fatigue due to a stress is much lower. There is time available for doing something else and keeping the nerves and energy in the healthy state.
- Swing trading may be carried out with the use of a regular computer or smartphone with the installed broker’s terminal. There are no high requirements to the connection speed and advanced technological solutions.
- Swing traders usually have a permanent job or another source of income, using which they may compensate or decrease trading losses.
- As well as any other trading style, swing trading may result in significant losses. Since swing traders keep their positions longer than intraday traders, they also take risks to make bigger losses. Especially the risk of losses increases due to holding the overnight position.
- Swing traders rarely enter at better prices. They check the chart 1-2 times a day and are satisfied with what the market offers at the moment of the position opening.
- A longer period of time of waiting for a signal for entering a position. If scalpers receive signals with the frequency of meowing of an annoying cat, swingers may wait for a setup day after day.
Middle-term traders hold positions from several months to several years (however, there are no strict time-frames here; some Internet sources state that middle-term trading is holding positions during several days).
Below is an example of a successful middle-term portfolio.
An investor bought stock for a middle term (period of holding is about 1.5 years) and received a ‘spin-off’ in the amount of 24.46%.
Middle-term trading is the most characteristic for stock, since such dynamic instruments as currencies and oil could be very volatile in the middle-term perspective.
Advantages of middle-term trading:
- It preserves emotions which are connected with trading. It always keeps your point of view clear and helps to look at the company’s perspectives of growth and resilience of its business model from different points of view.
- High-technology terminals are not required. An example of a successful middle-term trader is described in the classical literature. He bought stock over the phone using information from a newspaper which arrived with a several days delay.
- Commissions do not exert a decisive impact on the final result.
- A trader has a lot of free time.
- There are wide possibilities for the market selection. While long-term investors prefer stable companies from the top-100, middle-term investors may have unknown but perspective stocks in their portfolio.
- A trader needs to have knowledge and skills to conduct a fundamental analysis.
- A trader needs to assess a large number of stocks, sectors and industries in order to select the best ones for buying.
- Holding a position for several months doesn’t fit traders who used to act energetically.
When people speak about long-term investing they, first of all, mean the stock market and buying the company stock. However, the picture below shows that the most successful investment (where the period of holding is the past 10 years) is bitcoin (how to make money on cryptocurrencies).
The main cryptocurrency exceeded all top stocks by several orders of magnitude.
‘Buy and hold’ fits the logic of a long-term investor the best. There is a funny joke on this subject:
A girl comes to her father, a rich investor, and asks to give her money:
- Papa, give me 100 dollars. I want to go with my friends to the shop and then to the nightclub.
- Sorry, my darling. All my money is in stocks.
- And when will you sell the stocks?
Pros of long-term investing:
- Less distresses: there is no need to monitor the stock market all the time.
- Time saving: you can devote the time, saved from constant market monitoring, to other fruitful types of activity – those that are connected with the exchange and those that are far from it.
- Less efforts: you do not need to study various trading strategies or platforms, since you will not be an active intraday trader.
- If you do not take into account specific features of a specific country, but look at the situation in general, the long-term trading helps to save on taxes. It could be that the long-term capital growth would be taxed in the amount of 5-15% while short-term traders may pay about 20-30% of taxes.
- Receiving dividends. Your capital grows not only due to the increase of the stock value but also due to the dividends paid by the company to stockholders.
Cons of long-term trading:
- Investments: long-term trading, as it follows from the name, requires you to have a free capital. And it should be free for many years to come. You should be ready for a situation when a part of your capital is blocked in one stock and you will not be able to use it for making profit on short-term speculations.
- Deep knowledge. Long-term trading requires the advanced understanding of the assets you invest in. You cannot just make decisions on the basis of certain news, advice or rumors. It is also not sufficient to rely only on charts or signals of indicators for buying or selling. You should be a specialist in the fundamental analysis of both an individual company and the global economy.
- Long-term trading requires patience. Inability to stay calm would create problems for an investor in the long-term perspective.
- Age restrictions. You should have some life horizon in order to use a profit from investing. In case you are 60, it is rather late to start your investing career for obvious reasons.
HFT, scalping, intraday trading, swing trading, middle-term trading and long-term investing – all these types have their advantages and disadvantages. None of these styles is better than another. Moreover, the global markets become more competitive.
For example, the following picture shows how more complex it becomes to select stocks for your portfolio:
This picture shows that ever fewer stocks perform better than the general stock index. It means that it becomes more difficult to select a correct investment.
The situation in other markets is similar. Beginners push, competition is growing, robots take niches and it becomes more and more difficult to make a profit.
What to do?
- Traders should select that approach which fits their skills, preferences and lifestyle best of all. However, it doesn’t mean that it is impossible to combine approaches. For example, Richard Wyckoff, a big authority of the stock markets, wrote in one of his books that he “speculates for the sake of investing”. In other words, he made money on short-term operations in order to invest into long-term projects.
- Traders should take care of acquiring the trading advantage.
Whatever trading type you select, OrderFlowTrading wishes you to achieve success. Test our trading and analytical ATAS platform for achieving your personal advantage in the financial markets.