In our last lesson we finished up our discussion on big picture fundamentals with a look at the Conference Board’s Index of Leading Economic Indicators. In this lesson we are going to start a new series of lessons which is meant to tie everything together that we have learned up to this point starting with an explanation of the different types of traders.
While there are many different styles of trading most if not all styles can be categorized in to one of three broad categories which are: Day Trading, Swing Trading, and Trend Trading.
According to data on the number of searches for each of the above categories, Day Trading is by far the most popular type of trading so we will start by analyzing the advantages and disadvantages of this type of trading.
The definition of a day trader is a trader who typically completes both the purchase and the sale of a financial instrument within a single trading day. One of the biggest advantages that I think most traders would site about day trading is that since the trade is closed out before the end of the trading day you do not have overnight exposure. This is an especially important point in the stock and futures markets where it is difficult or in some cases not possible to close a position after normal trading hours.
As many of you already know, the difference between the close of the previous day and the open of the next day can be large if a major event happens outside of trading hours. This puts non day traders who hold positions overnight into a somewhat risky position where they could be forced to take a much larger loss than they otherwise would have.
The second big advantage that I think many traders would site is that good day traders are more nimble, as they move in and out of the markets quickly seeking trades with a high success rate and cutting their losses quickly. This allows them to take advantage of more opportunities than are available to longer term traders.
The biggest disadvantage that I think most traders would site about day trading is the greater transaction costs that are involved. Very simply, because day trader’s trade more they generate more commissions and pay the spread a greater number of times. As their transaction costs are higher they must generate greater profits than strategies which do not generate as much in transaction costs, all else being equal.
The second disadvantage to day trading that I think many traders would site is the amount of resources that are required in relation to longer term methods of trading. This is true from a time, concentration, and technology standpoint as in general day traders spend more time in front of the screen, have to have more concentration, and more technology such as high powered charts and news feeds than longer term traders do.
So with all this in mind why is it that day trading is by far the most popular type of trading? One reason in my opinion is the advantages that I have listed above which are very appealing to many professional traders. Unfortunately however my opinion is that the bigger reason is that day trading allows people who have gambling tendencies to get the biggest gambling fix so to speak from the market.
As we have discussed in our series on the psychology of trading this is not a healthy reason to trade and is one of the major reasons why the large majority of day traders fail.
That concludes our lesson. In the next lesson we are going to look at the second most popular style of trading, swing trading. An Introduction to Swing Trading.