When Day Traders Aren't Day Traders - dummies

When Day Traders Aren’t Day Traders

By definition, day traders hold their investment positions for only a single day. This is important for a few reasons:

  • Closing out daily reduces your risk of something happening overnight.
  • Margin rates — the interest rates paid on money borrowed for trading — are low and in some cases zero for day traders, but the rates go up on overnight balances.
  • It’s good trade discipline that can keep you from making expensive mistakes.

But like all rules, the single-day rule can be broken, and probably should be broken sometimes. The following sections show a few longer-term trading strategies that you may want to occasionally add to your trading business.

Swing trading: Holding for days

Swing trading involves holding a position for several days. Some swing traders hold overnight; others hold for days or even months. The longer time period gives more time for a position to work out, which is especially important if it is based on news events or if it requires taking a position contrary to the current market sentiment. Although swing trading gives traders more options for making a profit, it carries some risks because the position could turn against you while you are away from the markets.

There’s always a tradeoff between risk and return. When you take more risk, you do so in the hopes of getting a greater return. But when you look for a way to increase return, remember that you will have to take on more risk to do it.

Position trading: Holding for weeks

A position trader holds a stake in a stock or a commodity for several weeks and possibly even for months. This person is attracted to the short-term price opportunities, but he also believes that he can make more money by holding the stake for a long enough period to see business fundamentals play out. This increases the risk and the potential return because a lot more can happen over months than can happen in minutes.

Investing: Holding for months or years

An investor is not a trader. Investors do careful research and buy a stake in an asset in the hopes of building a profit over the long term. It’s not unusual for investors to hold assets for decades, although good ones sell quickly if they realize that they have made a mistake. (They want to cut their losses early, just as any good trader should.)

Investors are concerned about the prospects of the underlying business. Will it make money? Will it pay off its debts? Will it hold its value? They view short-term price fluctuations as noise rather than as profit opportunities.

Many traders pull out some of their profits to invest for the long term (or to give to someone else, such as a mutual fund manager or hedge fund, to invest). It’s a way of building financial security in the pursuit of longer goals. This money is usually kept separate from the trading account.