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The stock market has different kinds of traders, each having a different perspective of the market. While some traders prefer holding stocks for a fairly long time, other traders prefer short-term trading. Another category is investors who stay invested in companies for a considerable duration. The end objective, however, is to earn profits.
In today’s article, we will analyse the perspective of short-term trading and some strategies that short-term traders use to make profitable trades.
What is short-term trading?
If you are a passive participant in the stock market, you may buy stocks, hold them for a while, say a few months or years, and then sell them off.
Short-term trading, conversely, involves taking positions quite often. Each position lasts for a few days or weeks. Some short-term trades last for less than a day. The objective for short-term traders is to benefit from short-term price fluctuations.
Unlike long-term traders who observe the market’s pattern for a long time before making decisions, short-term traders look for every price movement as an opportunity to book profits.
Risks associated with short-term stock trading
Now that we understand short-term trading, it must be clear that short-term traders must thoroughly focus on the market. Though profitable, short-term trades are risky.
Unlike long-term trades, short-term strategies do not give time for the market to settle. So, the uncertainty and volatility are high. While profits are possible, losses are equally possible. Traders may not always find a counterparty, so there is also a high liquidity risk.
Besides, short-term traders must constantly focus on specific securities, because of which they may not find the time to diversify their portfolios. So, the lack of diversification can increase their portfolio’s risk exposure.
Also, the number of transactions entered by short-term traders is high. So, the transaction cost, brokerage, etc., increase, thereby taking away a significant portion of profits.
Short-term trading types
The three popular short-term trading types are day trading, scalping and swing trading.
Intraday or day trading refers to squaring off positions on the same day. So, a trader who buys securities in the morning must square them off before the market closes on the same day and vice versa.
Scalping is better classified as a strategy for intraday trades than a separate type of short-term trading. It is where traders enter high-volume transactions to make significant profits, even when the price fluctuation is low. Such trades usually last a few minutes to hours, and traders look for every little fluctuation here to book profits.
Swing trading, contrary to scalping and intraday, involves holding shares overnight. Traders may hold existing positions for weeks to months until they take new positions again. Swing traders observe market trends for longer periods, unlike day traders.
Strategies for short-term trading
Popular trading strategies among short-term traders include momentum, reversal, range and breakout trading.
Momentum trading is a strategy where short-term traders tend to trade the trend. They identify the current trend and its strength, based on which they plan their entry and exit positions. They consider both price and volume to assess the trend’s strength here.
Reversal trading, on the other hand, is a strategy to trade against the trend. Traders look for indicators that suggest a potential reversal and take positions accordingly. Such traders follow the contrarian approach and believe the market will reverse its trends soon. Bullish reversal and bearish reversal patterns help traders watch out for reversals.
The next strategy used by short-term traders is range trading. The range here refers to the support and resistance levels of stocks. While support indicates the least a stock’s price can fall, resistance indicates the highest it can reach. Traders calculate these levels and stay in between them while taking positions.
Breakout trading is another strategy that works opposite to range trading. Traders using breakout wait for stock prices to break out of the support and resistance levels, i.e., either below the support level or above the resistance level, based on which they take their positions.
Indicators for short-term trading
Some of the best indicators for short-term trading strategies are:
- RSI: The Relative Strength Index (RSI) is an indicator that determines the strength of a trend. It gives a number between 0 to 100, which suggests whether stocks are overbought or oversold based on which traders take entry and exit positions.
- Moving averages: These indicators are also useful as they help in easing out the noise of price fluctuations to depict a trend that shows the direction of stocks.
- Bollinger bands: This is a set of three lines formed from moving averages. The distance between each line shows how volatile the market is.
- Candlesticks: Candlesticks are chart patterns that show different price points of stocks for a specific period. These help analyse trends and reversals to determine the entry and exit.
Bottomline
Short-term equity trading is a risky pitch, so strategising trades using relevant indicators is of utmost importance. Since these trades demand quick execution, the risk of slippage is also high.
Hence, short-term traders need to use a combination of indicators to determine the trend and its strength accurately before strategising trades.
FAQs
Short-term trading provides flexibility to traders. They also provide liquidity to traders since trades settle quickly.
Short-term trading requires quick execution. Between placing the order and actually executing it, the price may have changed when the market is volatile. This may affect the trader’s desired profits and is called the risk of slippage.
Yes, intraday trading can be profitable if you choose the right stocks to trade with. Trading with the trend and strategising accurately while taking positions at the right price point can help profit from intraday trades.
Margin trading or leverage trading is where traders use margins to trade, where they borrow loans to take larger positions. While margin trading can be beneficial, it is also risky, as margins double the losses when the situation is unfavourable.
While all forms of short-term trading types can be profitable if strategised well, the risks involved are high. However, swing trading, among the others, is fairly lower in risk because it gives time for the market to settle and does not pressurise traders to take immediate positions.