Scalping is trading on very short time frames, like 4-10 minutes. The profits are much smaller but more frequent. Scalping suffers from the fact that the fees paid to your broker will usually take a big percentage of your total profits. To be successful at scalping you need to have more than an 80% winning percentage. This sounds impossible but I have done it and so have others. However, even at 80% winners I only cleared about $20 net profit after 40 trades due to the effect of trading costs and the 20% of losers (losers are usually bigger than winners to get to 80%+). Traders who scalp are probably better served by other trading methods but are either too impatient to wait longer or they prefer the excitement of this type of trading.

Day Trading

Day trading is the buying and selling of securities on the same day such that at the end of the day your account is back in cash with no positions carried overnight. Day trading is common and many people have achieved financial independence with it. Scalping (mentioned above) is a type of very short term day trading. Many day traders are breakeven traders because they don’t manage losers properly and they fail to let winners reach proper profitability (we will discuss this more later). In my experience day trading is the least risky (no overnight risk) and most profitable (percent profit per day) of the time frames but it may take you a while (months/years) to master it.

You should always paper trade for a long time and then slowly transition to real money by alternating real and paper money. Also, the first year that you do real money you should keep you trade size small because large trade sizes will be psychologically difficult. If you go to real money too soon or you increase your trade size too soon then you will trade like scared money, which will lose you money. Not practicing with paper money and scaling up the real money trade size too soon is the most common cause of traders failing (in my opinion). If you are jobless and think that you can use your last little bit of money to become a day trader then forget it, that is too much pressure. Set the money aside and stabilize your living situation first, then start to learn without that pressure.

Swing Trading

Swing trading of stocks is the most common of trading styles and the one where new traders often find the greatest early success. In swing trading you hold most positions overnight and for several nights, weeks, or even months (but not years). It is very useful for retired people who have a substantial amount invested. To make a living by swing trading you should have more than $150,000 to trade with. Returns of more than 20% per year are hard to achieve consistently unless you are good at boosting your swing trading with the selling of options. You should plan on making no more than 15% per year after you are good at it. Once you have a track record of more than two years then you can use that to plan your budget. You can also mix in a little day trading to improve your income.

Active Investing

Active investing is where you hold positions for long periods of time for purely fundamental reasons and do not try to cash in on the ups and downs of the market. In active investing you monitor the health of your holding and make revisions as needed to stay with the best stocks. It is the type most commonly advocated by typical Wall Street types and yields a rate of return generally below 11% per year.

Position Trading

Position trading of stocks is used extensively by hedge funds to manage their portfolios. It is in between swing trading and active investing in that any one position is usually held for a long time (active investing) but there are many revisions to that position as the market prices rise and fall (swing trading). A position trader has “core holdings” that almost never are completely sold out but he sells some of it into rallies and buys it back on subsequent dips. Depending on your skill level you can probably get returns at least as high as in swing trading because swing traders usually sell too soon, leaving behind additional profit that could have been made had he stayed in longer. You can also effectively hedge your long positions with short positions or options to reduce the effect of selloffs. More on this later.

Market Neutral Trading

This is a type of swing or position trading where you seek to remove the price action in the overall market by pairs trading or being otherwise fully hedged. Hedging is where you create an offsetting position, such as being long Walmart and short JC Penny. If Walmart is a bullish stock and JC Penny is having a hard time then you will make money on them as the difference in value widens over time (Walmart going higher and JC Penny going lower). This strategy removes much of the effect of the overall market fluctuations and will lower your overall return but it makes that return more reliable.

Scott Tofel

Scott Tafel was the founder and principle partner in Falcon Trading Systems: computers for traders. He has been a trader since 1999. Mr. Tafel spent 27 years working in the Nuclear power industry, principally as a Nuclear Reactor Operator.