Navigation skipped

Active Trading: Strategies to Consider

Discover active trading and the different types of active trading strategies.

Updated

10 min. read

Play video in YouTube player, Active Trading: Strategies to Consider, opens in a new pop-up

Learn about active trading and explore different active trading strategies that can help maximize your return on investment.

Active traders can use a variety of strategies to achieve their goals and each approach has its own risks and rewards. In this article, we will discuss the most common active trading strategies, how they are used, and the risks associated with them.

What is active trading?

Active trading is when you buy and sell stocks or other securities on a regular basis, with the goal of making short-term profits. An active trader might hold a position for minutes, hours, days, weeks, or longer. There's no set holding period for active trading, but holding periods tend to be shorter than a buy and hold approach, which generally involves holding periods of many years.

Active trading can be risky, which means that larger gains and losses are both possible in shorter periods of time.

What investors should consider before starting active trading

Active trading can be a profitable way to invest, but it is not for everyone. It involves trying to make short-term predictions about price patterns. If you guess right, you can make a healthy profit quickly. If you guess wrong, the losses can mount.

Before starting active trading, investors should consider the risks and rewards of each approach and how it fits with their goals and risk tolerance. They should also make sure they have enough funds to cover losses, as active trading can be volatile, and markets can move fast on breaking news.

Make sure to read the Learning Centre article on "Five things you should know about active trading" to learn more.

Active trading vs. passive trading

Passive trading might be more commonly referred to as 'buy and hold' investing. It's passive in the sense that it doesn't require as much ongoing oversight once you've placed your trades. For example, a passive trader might research many different companies and build a portfolio of 20 different positions to hold for the very long term, perhaps 10 years or more. They might occasionally tweak their portfolio by making a few transactions once every few years, but for the most part they’re holding on to their picks.

Active trading requires much more ongoing attention. While there are many different types of active trading strategies, you could buy and sell the same stocks that a passive trader would. However, you might buy and sell the same stock repeatedly as you try to capture the performance of short-term patterns.

For example, let's say stock XYZ goes up 10% in two years. The passive trader, if they bought and held, would end up with that 10% gain (less commissions). But during those two years, the stock will go up on some days and go down on others.

An active trader might try to buy the stock after a down day with the hopes of capturing a rebound in price the following day, and then sell out of the position. They might buy in and out of the same stock multiple times a day, trying only to invest when they think the stock will go up. Their goal would be to try to get a much higher return than the 10% over two years by holding more often when the stock is going up and holding less often when the stock is going down.

Active traders will want to become acquainted with the trading tools available on their trading platform such as streaming quotes, how to use fundamental analysis screeners and technical analysis charting tools to identify trading opportunities that meet their criteria, and the use of news alerts and announcements to help find opportunities.

“Before starting active trading, investors should consider the risks and rewards of each approach and how it fits with their goals and risk tolerance.”

Types of active trading strategies

Day trading

Day traders buy and sell stocks during the same day, sometimes multiple times. The price of securities rarely move in straight lines - they can fluctuate second by second, and day by day.

Day traders hope to make money by predicting price movements during a single trading day and will generally exit all positions by the end of the day. An example of a technique a day trader might employ is to monitor level two quotes to try and get a read for the depth of the market on both the bid and ask side of the order book.

In tandem with one-click trading, it allows for a trader to execute quick trades to ride any momentum they might see in intra-day price movements from second to second. One thing to be mindful of with day trading is the cost of executing trades, as day traders can place many trades per day.

Position trading

Position trading is a longer-term active trading strategy where you buy and sell stocks or other securities with the goal of holding them for weeks or months.

Unlike day-trading, where you're buying and selling stocks during the same day, position traders are looking to ride a medium-term wave of performance. For example, a stock might gain 15% in one year, but perhaps it started at $100 per share in January and climbed to $150 per share by August before tumbling down to $115 in December. The position trader would ideally look to just be invested during that strong growth phase.

A position trader might select a suite of indicators that they monitor to help identify overbought or oversold conditions for a stock. If these technical indicators confirm price trends, this might signal to the position trader to initiate a trade. Some position traders can hold positions for a few years.

They may use a combination of fundamental and technical analysis tools to aid in their decision making. For example, if they’ve identified a company that has good fundamentals (such as having a high amount of cash on hand relative to their share price) and has a technical signal (such as a low Relative Strength Index (RSI) score which suggests an oversold condition) this might give the trader the confidence to buy that stock. A brokerage platform that specializes in active trading provides access to both types of analytical tools for traders.

Swing trading

Swing trading could be considered as being somewhere between day trading and position trading. The holding periods are longer than day trading and shorter than position trading. But the duration of holding periods is not the only factor.

If you think of a playground swing, the moment the swing reaches the peak of its arc and starts to change direction is where a swing trader might want to pay attention. They are looking for opportunities that arise when a medium-term trend is ending or changing direction. This can be a volatile time for a security’s price.

For example, tech stocks can go on strong bull runs for years and sometimes analysts and investors start to question the very high prices. They are happy to stay invested if the trend continues but know that a reversal can be sharp if investor sentiment changes.

A swing trader might seek to capitalize on trying to time the end of a bull-run by shorting the stock in hopes of a quick decline.

Sometimes, they may look for stocks that have been undervalued for a long time and suddenly start to see a rebound as an opportunity to buy the stock. They may also use call options and put options to try and capitalize on shorter-term price movement predictions.

A swing trader tends to rely mostly on technical analysis tools as they believe any stock, with solid or poor fundamentals, will not move in straight lines. They may monitor technical indicators such as trade volume and moving averages.

Scalp trading

Scalp trading is an active trading strategy that involves looking for anomalies in the bid and ask price spreads for stocks.

The difference between the highest quoted bid price and the lowest quoted ask price for a stock is known as "the spread". Usually, this spread is quite small. For example, a stock that trades around $50 per share might have a bid price of $49.98 and an ask price of $50.02. This would represent a spread price of 4 cents.

Sometimes a security can have a larger than normal spread. If a scalp trader can buy and sell within this spread in a very short period (seconds or minutes) they might be able to generate a few pennies per share in gains. They'll have to subtract any costs of trading which will eat into their returns. This means the returns are likely quite small.

To generate sizeable profits, you would have to make large trades. This exposes the investor to the risk of the price moving against their position. Today, investors would also be competing against professional market makers and high-frequency trading computers. Scalp trading has become less popular over time as a result.

Concluding thoughts

Active trading strategies are used by many investors, but investors should be aware of the risks associated with each type of active trading strategy.

Beginners should do their research and understand the risks before starting active trading. It requires more time and attention in managing your investments and of course, the higher risk involved means that not only could you see larger short-term gains, but you could also see larger short-term losses.

But for our margin trade, we would be holding $100,000 of stock XYZ to start. If that went up 10%, we would have $110,000. We would still owe $70,000 on our loan, and if we sold our position and paid off the loan we would have $40,000 left over. We would have increased our cash position from $30,000 to $40,000, which is a gain of 33.33% (this gain will be reduced by trading commissions as well as the interest on the borrowed funds).

This sounds lucrative, but consider what happens if stock XYZ went down 10%. Our $100,000 initial position is reduced to $90,000. We still owe $70,000, so if we sold our position we would be left with $20,000 after paying back the loan. We would have lost 33.33% relative to our starting $30,000 cash position, and again we would additionally have to subtract trading commissions and the interest charged for borrowing funds.

FAQs

Q: Which active trading strategy is best for beginners?

A: Many active traders use a combination of strategies. They may hold some stocks for months (position trading), while trading in and out of other stocks during a single day (day trading).

Q: How do I become a successful active trader?

A: It is important to spend time researching not only your trades, but also the various order types you can use to help you such as stop-loss orders, trailing stop orders, and more. Make sure to visit the Learning Centre to learn more about order types.

Q: Which active trading strategy is most profitable?

A: Swing trading allows for extreme performance (both positive and negative) in short periods of time as it involves looking for moments where pricing can be volatile. This carries a lot of risk as well. However, keep in mind that what works for some investors will not necessarily work for other investors.

Q: How do I become an active trader with BMO InvestorLine?

A: If you trade on a frequent basis you could qualify for our 5 Star program and unlock exclusive benefits. Enjoy free access to BMO Active Trader when you make 15 or more trades per quarter or invest at least $250,000. You’ll also get: