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When you are looking into investing in stocks, one of the first decisions you may consider making is whether you are a short-term trader or a long-term investor. Based on that, you will need to choose the approach you exercise in your daily trading routine.
For most stock investors, who are looking for a positive outcome generated over time, long-term investments may be, for example, the way to go as they can better manage risks, are more predictable, and require less management in comparison to other investments.
For some investors, looking for a positive outcome, however, short-term trading can be an appealing – but quite risky – business. This type of trading requires a slightly different approach to standard stock investing. Make sure you’ve read through our articles on the basics of stock trading explained and the mistakes that novice traders make in stock trading, before entering the high-octane world of short-term trading.
If you are ready to take the plunge, though, in this guide we’ll take you through the basics of short-term trading. Here are the 3 main steps for trading stocks on short timeframes.
1. Identify the right stocks
Some investors get pretty good at spotting stocks with long-term potential, but it can be more difficult to identify promising stocks in the short term.
It has been observed that experienced traders hardly ever keep stocks for more than a day, and so being able to predict short-term movements is crucial for their trading methods. They also, for instance, tend to choose well-known and relatively stable industries, like the ones in our list of the top ten companies for revenue.
There are several rules for spotting stocks with good short-term potential:
- The moving average of particular stocks for the last 15, 20, 30, 50, 100, and 200 days might indicate the stock’s potential. If the stock values are increasing exponentially, it might be a good candidate for short-term investment. Similarly, a stock for which the moving average is leveling out might be a candidate for shorting. However, this is not absolute and depends on a case by case basis.
- It’s also important that short-term investors research market cycles. It has been identified that since 1950, most stock market gains have been between November and April, with the rest of the year relatively flat. This kind of cycle is all but invisible to the long-term investor, but it may be very important for short-term trading.
- Another valuable component in short-term trading is getting a good idea of the market trend. For example, for short-term investments, going against the trend, and buying when everyone else is selling (or vice versa) is inadvisable.
2. Technical analysis
It is necessary to recognize that the outcome in short-term trading is most often built upon detailed technical analysis of potential stocks. This is easily overlooked by novice investors, who mistakenly believe that large, fast gains can be made from stocks because they are highlighted in the newspaper or in automated prospect research.
In reality, the market will price in every factor that will affect a stock extremely quickly, and even before short-term investors are able to realize its potential. The outcomes of short-term trading largely depend on spotting patterns in a stock’s performance that others may have missed.
Technical analysis is a great way of codifying and formalizing this investigative process. By applying a set of repeatable principles, this approach might help you to spot patterns in a stock’s cost that would otherwise be overlooked. It might be, for instance, that the smartphone market is booming, but the performance of individual companies will vary widely within this general trend. Technical analysis may reveal these patterns, and help a trader decide on their approach in short-term stock trading.
However, it is also very important to keep in mind that there are never 100% guarantees.
3. Hedging and managing risk
Managing and hedging risk is one of the most important aspects of stock trading, but it is even more important in short-term trading due to the increased risk profile.
There are several ways to manage risk in short-term stock trading which should be taken into consideration. First and foremost, it is important to make use of sell stops or buy stops, which can automatically sell your stocks when they drop below (or rise above) a particular price. These tools might help in protecting a position from market reversals. For short-term trading, a common approach might be, for instance, to set a sell stop or buy stop within 10% to 15% of the opening price.
Secondly, be aware that in short-term, high-volume trading, fees and charges can start to add up quickly, and if you are not careful they might wipe out the entire position. This is why online brokers are popular for short-term trading – their fees are lower. They might charge a small fee per trade, but you’re still only paying an average of $7 per trade rather than high brokerage fees and commissions.
Finally, traders might consider having a portfolio as diverse as it would be if they were looking to hold on to the stocks for a long time. Just because one would sell their stocks quickly doesn’t mean they should forget about the basic principles of investing. As we’ve seen in the industries that have done well from the pandemic, putting in place fallback plans for rapid market fluctuations is crucial for any investment strategy, short-term stock trading included.
Short-term stock trading may be a suitable approach for experienced traders, but it has to be exercised with caution. As with other investment instruments, the techniques that may lead to higher outcomes are generally the most risky ones, which is why it is necessary to ensure deep understanding of the principles of stock trading. Before attempting to leverage short-term stocks, traders need to practice, for instance, using the Practice account on the platform.