When an Investor Might Want to Consider Day Trading - dummies

When an Investor Might Want to Consider Day Trading

Many day traders are also long-term investors. Sure, they trade for the short term, but they regularly take some of their profits and put them toward investments that have a longer time frame. It’s smart risk management for a business that has a high wash-out rate. After all, even a short-term trader has long-term goals.

But does it ever make sense for a long-term investor to take up short-term trading? It might make sense for one of the following three reasons.

Don’t try riskier trading strategies unless your portfolio can handle the risk.

The idea proves to have a short shelf life

It happens to every long-term investor once or twice: He buys a security intending to hold it forever, and within a few days or weeks, some really bad news comes out. Or he buys only to see two days later that the company is being sold. That great long-term buy-and-hold idea no longer fits the original parameters, so it’s time to sell. Despite the goal of holding forever, it’s time to get out and move on, even if it’s only a day later.

Your research shows you some trading opportunities

Good investors monitor their holdings, and some become intimate with the nuances of a security’s short-term price movements even though the objective is to hold the position for the long term. An investor who gets a feel for the trading patterns of a specific holding might want to turn that into swing trading and day trading opportunities. Yes, it adds risk to the portfolio, but it can also increase return.

You see some great short opportunities

Short selling allows a trader to profit from a decline in the price of a security. The trader borrows a security from the broker, sells it in the market, and then waits in hopes that the price goes down. When it does, the trader buys the security back at the lower price and repays the loan, keeping the difference between the purchase price and the sale price.

Because the broker charges interest on the loaned securities, short selling can get expensive. Traders who sell short are usually looking for a relatively short-term profit, not necessarily over a single day, but over months rather than years.

In addition to the interest, short selling faces another risk, which is that the security can go up in price while the trader is waiting for it to go down. In order to reduce that risk, most short sellers do careful research to make sure that they’re right about the security being all wrong.

For the investor who loves to do research and who has some appetite for risk, short selling is a way to make money from those securities that would make terrible long-term holdings because it seems obvious that they aren’t going to do well. When these investors come across securities that are headed for trouble, they can short them in the hope of making a nice short-term profit.