Active Trading: Meaning, Strategies, Example (2024)

What Is Active Trading?

Active trading refers to buying and selling securities for quick profit based on short-term movements in price. The intention is to hold the position for only a short amount of time. There is no precise time measurement for active trading. Day traders that make tens or hundreds of trades per day would be very actively trading, while a swing trader that is opening or closing positions every few days may be considered by many to be an active trader as well.

Understanding Active Trading

Active trading seeks to profit from price movements in highly liquid markets. For this reason, active traders generally focus on stocks, foreign currency trades, futures, and options with lots of volume which allows them to get into and out of positions with ease.

Active traders typically use a high volume of trades to make profits, since the price swings likely to occur over the short term tend to be relatively small. They will also use a variety of order types depending on the situation. To capture a breakout they may use a stop order. For example, if there is resistance at $50, they may set a buy stop order at $50.05, which sends an order to buy if the price breaks through $50 and reaches $50.05.

A stop-loss order—a stop order used to limit losses—helps keep losses manageable if the price moves against the trader.

To capture a favorable price the active trader may use limit orders. If a stock is trading at $30, but a trader wants to see if they can buy at $29.50 on a quick drop, they could place a limit buy order at $29.50. Similarly, they could place a limit sell order to exit the position at $31.

Such orders allow the active trader to buy and sell without having to watch the price every second of the day. They set their orders and know that if the price reaches those levels their orders will trigger.

Since active traders trade within short periods time, fundamental or economic aspects typically don't play a role in the trades. Rather, technical and statistical analysis play a bigger role, with many active traders trading based off of price action or technical indicators or concepts.

Active Trading Strategies

Active traders typically fall within three categories. Traders in each category tend to trade different amounts and on different time frames, even though they are all short-term traders.

Day tradinginvolves buying and selling a security within the same trading day, usually in an attempt to take advantage of a specific event expected to influence the stock’s price. For example, a day trader may trade the volatile price action that follows a company’s earnings announcement or a change in interest rates made by a central bank. These traders will typically use one, five, or fifteen-minute charts.

Scalpinguses a high volume of trades to take advantage of small price discrepancies over the very short term. For example, traders might use the significant leverage available from a foreign exchange broker to amplify profits from tiny movements in price based upon tick charts and one-minute charts. Many automated and quantitative trading strategies fall within the scalping category.

Swing tradinginvolves positions held for a period of several days to several weeks. The swing trader is taking advantage of price moves that occur on hourly, four-hour, and/or daily price charts.

Active Trading Compared to Active Investing

While they sound similar, active trading and active investing describe different market approaches. Active investing refers to activities entered into by investors or fund managers seeking to rearrange a portfolio of securities. Active investors constantly seek alpha, which is the difference between a return on an actively managed portfolio compared to an index, benchmark, or similar passive investing strategy.

Proponents of passive investing, the opposite of active investing, frequently cite that active traders rarely outperforming passive index funds. This is primarily due to the increased commissions and costs of active trading. That said, many traders do routinely outperform the indexes, which is why active trading has such an appeal because of its potential for high returns (and higher risk).

Active trading is shorter-term than active investing. While an investor may be active, they often intend to hold positions for years. Active traders are interested in much shorter-term trades.

Example of Active Trading on a One-Minute Chart

Active traders use loads of different strategies. Even amongst day traders, it's unlikely that any two will trade exactly the same. The following chart shows how a price-action based day trader may trade a one-minute chart of the SPDR S&P 500 (SPY).

In the example, the trader is watching for trends to develop. In the case of a downtrend: lower swing highs and lower swing lows. In the case of an uptrend: higher swing highs and higher swing lows.

They wait for consolidations and then strong shifts back in the trending direction. They exit with a loss if the price reverses against them. They exit with a profit when the price consolidates again, or when the price starts to move aggressively against the trend direction for at least one minute. Arrows mark trades in the arrow direction, while the "x" marks the exit for the trade.

In a three-hour span, seven trades were opened and closed, for a total of 14 transactions.

The first trade was a winner, the second a loser, the third a winner, the fourth a small profit, the fifth a small loss, and sixth and seventh were both winners. The active trader, like any trader, is simply trying to make more than they lose on the trades they take, overall. Since commissions and fees can add up quickly when actively trading, winnings must be enough to overcome these costs.

The strategy discussed is for demonstration purposes only.