Paddy Osborn, Academic Dean and Managing Director, London Academy of Trading
Trading or investing in stocks (or equities) involves buying and selling shares of publicly traded companies on a stock exchange. Due to the historical long-term growth of stock prices – and regular dividend payments that can be earned from owning company shares – it is one of the most popular asset classes for longer-term investors, allowing individuals to invest in businesses and profit from their success.
Long-term investors typically buy and hold stocks for many months, years or even decades. Their analysis is usually “value-based”, focussing on fundamental analysis of company financials and growth potential, often ignoring short term market volatility.
However, in this article, we’ll be discussing the benefits (and potential risks) of shorter-term trading in the stock market (as opposed to longer-term investing), which involves more technical analysis and less fundamental analysis.
Firstly, short-term traders tend not to buy and sell actual shares. Instead, they use retail trading platforms to trade stocks via CFDs (Contracts For Difference) or Spread Betting accounts.
These types of accounts are leveraged, enabling speculators to take long (buy) or short (sell) positions in stocks without committing a significant amount of money up-front. The ability to “short” stocks also enables traders to profit from falling share prices as well as the obvious rewards that can be earned from buying a rising stock. There are a couple of different types of short-term stock trading, depending on your other commitments, and how much time you can spend at your screen each day.
Day trading involves buying and selling stocks within the same trading day, looking to profit from small intra-day price movements. This type of trading requires you to be at your desk throughout the trading session and tends to rely more on technical analysis then fundamental analysis. You need to make quick decisions on a minute-by-minute basis, and you need to have access to live news and price data, accurate charts and advanced trading tools to generate new trades.
Day trading has the advantage of holding no overnight positions, so you can switch off and relax once you’ve finished trading for the day, and you can take days off whenever you need to take a break. Also, you’ll be trading stock markets during active market hours, so there’s plenty of liquidity (which enables you to easily enter and exit positions), with relatively tight spreads (making trading costs cheaper), and plenty of price volatility to enable you to make good profits.
On the downside, you do need to be sitting at your desk for most if not all the trading day to monitor your positions and do your short-term analysis, and the more frantic nature of day trading can be quite stressful for some people.
Swing trading is rather more relaxed since trade duration can vary from a few days to a few weeks. Swing traders look to trade price “swings” during directional trends or to catch significant fluctuations between established support and resistance levels. As for day trading, swing traders need a strong understanding of technical analysis and chart patterns to help predict these short/medium-term moves.
Profits from swing trading can be comparable to those generated from day trading, but you do need to hold positions overnight (or sometimes over many nights), so you need to be able to relax and switch off while you still have risk in the markets.
One other significant potential risk is market gaps. Stocks will often gap up or down from last night’s closing price to this morning’s opening price. Occasionally (particularly after earnings announcements or shock news) the price may gap up or down as much as 10-20% at the opening, so your loss may be several times bigger than the risk you initially set with your stop loss. Of course, on the flip side, you may get lucky and score a massive win if the price happens to gap in your direction.
Conclusion
As we’ve discussed, the main potential benefit of stock trading is obvious – profitability – but personal satisfaction and a sense of achievement also rank highly for many traders.
However, we know that trading is by no means a risk-free activity. Stock prices can be highly volatile, influenced by factors like economic data, corporate earnings, geopolitical events, and investor sentiment. Traders must be prepared for the possibility of losing money, not just expect to win every time.
Effective risk management strategies are essential. These include setting stop-loss orders to limit potential losses, diversifying investments to spread risk, and using position sizing to manage your exposure to any single trade.
Emotional discipline is also crucial, since our natural human emotions (such as hope, fear, greed, revenge and FOMO) can easily lead to poor decision-making.
At the end of the day, success in stock market trading requires a good understanding of market principles, a clear strategy, disciplined execution, and hard work. Technology and markets will continue to evolve, and traders must continually educate themselves and adapt to new conditions to remain successful.
