Are you looking for a way to take your investments to the next level? If you’re tired of the slow and steady approach of passive investing, actively trading and investing in stocks might be the perfect solution for you. With the potential for higher returns, trading involves frequent buying and selling of stocks to outperform the market.
But don’t be fooled by the potential rewards – active trading requires careful attention to market trends, analysis of financial reports, and a thorough understanding of fundamental and technical analysis. In this article, we’ll take a closer look at the basics of active trading and investing in stocks. A comparison of the risks and rewards of each strategy is also made to help you decide if actively trading or investing in the stock market is right for you.
What is active trading in the stock market?
Active trading in the stock market involves actively buying and selling stocks in order to generate a profit in a relatively short timeframe, typically from days to weeks. This is in contrast to passive investing, where an investor buys a diversified portfolio of stocks and holds onto them for a longer term, typically on the order of years. In short, active investing requires a hands-on approach, typically by a portfolio manager or other so-called active participant.[1]
A key factor in successful active trading is staying informed about the stock market and the companies you’re trading in. This can involve reading financial news, studying company financial statements, and attending investor conferences.
The different active trading strategies
The different strategies used by active traders can be categorized based on how often trades are placed. The two most common types are day trading and swing trading. Each type of active trading strategy requires a different approach.
The day trading strategy
Day trading is a type of speculative trading where individuals buy and sell financial instruments such as stocks, options, currencies, or commodities within a single trading day with the aim of making a profit. Day traders rely on market fluctuations and technical analysis to identify short-term price movements and execute trades accordingly. A high level of skill, discipline, and risk management is essential for day traders. This trading strategy can be a very intense and stressful activity. Because of this, day trading is not a recommended trading strategy for everyone!
If you would like to start out in day trading, “How to Day Trade for a Living: A Beginner’s Guide to Trading Tools and Tactics, Money Management, Discipline and Trading Psychology: 1” by the #1 best-selling author, Dr Andrew Aziz (Link*), is a must read. It covers day trading in an easy-to-understand style, perfect for beginners.
For more experienced day traders, look no further than “Advanced Techniques in Day Trading: A Practical Guide to High Probability Strategies and Methods: 2” by the same author, Dr Andrew Aziz (Link*).
The swing trading strategy
Swing trading is a style of trading where individuals hold financial instruments for a period of several days to a few weeks with the aim of capturing larger price movements. Swing traders rely on fundamental and technical analysis to identify potential price trends and use various trading strategies to enter and exit positions. Unlike day trading, swing trading does not require constant monitoring of the markets and can be less intense and stressful. Because of this, swing trading is less risky than day trading, as additional analysis can be carried out over this time to determine when to buy and sell. However, it still requires a high level of skill, discipline, and risk management.
“How To Swing Trade: A Beginner’s Guide to Trading Tools, Money Management, Rules, Routines and Strategies of a Swing Trader” by Brian Pezim (Link*) is an accessible and practical guide for beginners interested in swing trading. Pezim provides clear explanations of essential trading tools, money management, rules, and strategies. The book’s straightforward writing style and numerous examples make it an excellent resource for anyone looking to learn the basics of swing trading.
Developing a successful active trading strategy
To develop a successful active trading strategy, investors need to determine their investment goals, risk tolerance, and time horizon. They can use fundamental analysis to evaluate a company’s financial statements and economic factors that may affect the company’s performance.
For example, an investor may analyze a company’s revenue, expenses, earnings, and debts. Investors can also use technical analysis to identify patterns and trends in stock prices. Technical analysis usually involves looking at charts, graphs, and other indicators that show a stock’s performance over time to help investors decide when to buy and sell.
“A Beginner’s Guide to the Stock Market” by Matthew R. Kratter (Link*) is an excellent primer for anyone looking to start investing in the stock market. Kratter provides a straightforward and easy-to-understand explanation of key concepts such as stock prices, dividends, and market indices, as well as an introduction to fundamental and technical analysis. He also provides some of the most common mistakes that new traders make, so that readers can avoid them.
What is active investing in the stock market?
Investing involves holding onto stocks for a longer period, usually years to decades. This is in contrast to the frequent trading using day and swing trading strategies. Active investing involves selecting stocks in companies that individuals would be willing to hold on to for the long term.
Stock selection for longer-term investment
Stock selection for longer-term investment requires thoroughly analyzing a company’s financial health. This method is less risky than day trading and swing trading and requires considerably less frequent trading.
Active stock selection for long term investment can be broken down into value investing, growth investing and income investing. Investors commonly use one or a combination of these strategies when pursuing longer-term investment objectives. Here we discuss each of these strategies with some examples.
Value investing
Value investing is a strategy that involves buying stocks that are undervalued by the market. The idea is to find companies that are trading at a lower price than their intrinsic value, with the expectation that the market will eventually recognize their true worth and the stock price will increase.
Value investing is one of the most popular longer-term active investment strategies, and many famous investors such as Warren Buffet and his mentor, Benjamin Graham, have used this approach to generate high returns over time.
“Buffett’s 2-Step Stock Market Strategy: Know When to Buy A Stock, Become a Millionaire, Get The Highest Returns” by Danial Jiwani (Link*) is an informative and practical guide for investors looking to emulate the legendary Warren Buffett’s investment approach. Jiwani breaks down Buffett’s strategy into two simple steps, emphasizing the importance of finding high-quality businesses and buying them at a reasonable price. He provides actionable tips and examples to help readers apply these principles in their own investing, as well as valuable insights into Buffett’s mindset and decision-making process. “Buffett’s 2-Step Stock Market Strategy” is a valuable resource for anyone looking to improve their investment performance and learn from one of the greatest investors of all time.
The Four M’s of value investing
One of the key principles of value investing is the concept of the “Four M’s”. The four M’s stand for:
- Meaning: An investor will usually have more success if the company has meaning to them. Also termed “circle of competence.”
- Moat: A moat gives a company some form of competitive advantage over similar companies.
- Management team: A strong management team is critical to a company’s success and increase in value.
- Margin of safety: The margin of safety is a factor included in the price estimate calculation. The investor will only buy a stock if it is trading at a significant discount to its intrinsic value, providing a buffer against potential market fluctuations. It is common for value investors to set a margin of safety of 50% to allow for any unknown factors that may result in the stock price falling.
Value investors pay close attention to a company’s fundamentals, such as its financial statements, earnings, and management team. They typically look for companies that have a strong balance sheet, a solid track record of earnings, and a management team that is aligned with the interests of shareholders.
Value investing is a long-term strategy and requires patience, as it may take some time for companies to trade significantly below their true value. It may also take some time for the market to recognize the true value of the stock. However, the potential rewards can be significant, as value stocks have historically outperformed the overall market over the long term.
The book “Rule #1” by Phil Town (Link*) is a compelling read for anyone interested in value investing. This book covers each of the four M’s in detail, and provides clear and practical guidance on how to identify great businesses, determine their intrinsic value, and invest with a margin of safety. Rule #1 will appeal to both novice and experienced investors alike.
Growth investing
Growth investing is a strategy that involves buying stocks of companies that are expected to grow at a faster rate than the overall market. The focus is on companies that have strong potential for revenue and earnings growth, rather than on their current financial position.
Like value investing, growth investors typically look for companies that have a strong competitive advantage. Competitive advantages include proprietary technology, a strong brand, or a large market share. They also tend to focus on companies in industries that are expected to grow rapidly. Companies such as technology, healthcare, and consumer goods fall into this category.
One of the key characteristics of growth investing is a willingness to pay a higher price-to-earnings (P/E) ratio for a stock. This is because growth investors believe that a company’s future earnings potential justifies a higher valuation.
Growth investing is a high-risk, high-reward strategy. Companies that are expected to grow rapidly may have high volatility and may be subject to market fluctuations. But, these companies also have the potential for significant returns for investors willing to take on the risk.
Dividend investing
Dividend investing is a strategy that involves buying stocks of companies that pay regular dividends to shareholders. Payments made by a company to its shareholders are termed dividends. A company will usually pay on a quarterly or 6-monthly basis out of its profits. Some companies will even pay dividends on a monthly basis.
One of the key benefits of dividend investing is the steady stream of income it can provide. Dividend payments can help to provide a cushion against market fluctuations. The payments can also help to smooth out overall returns over time.
Dividend investors typically look for companies that:
- have a strong track record of paying dividends,
- are financially stable, to continue paying dividends in the future, and
- are in mature industries, such as utilities and consumer staples, which tend to have more stable earnings and cash flows.
One of the key characteristics of dividend investing is that it requires a long-term perspective. Companies that have a strong track record of paying dividends are more likely to continue paying them in the future. However, a company can cut or eliminate dividends if its financial situation deteriorates.
Dividend investing can be a good strategy for investors who are looking for a steady stream of income, and who are comfortable with a more conservative investment approach. It can also be a good strategy for investors nearing retirement and looking for a more reliable and less volatile source of income.
“Dividend Investing Made Easy” by Matthew R. Kratter (Link*) is an excellent resource for investors looking to build a passive income stream through dividend investing. Kratter provides a simple yet effective approach to identifying high-quality dividend stocks and constructing a diversified portfolio. He also offers practical advice on how to reinvest dividends, manage risk, and avoid common pitfalls. The book is well-written and easy to understand, making it accessible to readers with varying levels of investment experience.
Note: Investors need to have a long-term perspective while investing in value, growth and dividend stocks, as it may take some time to realize the company’s value and/or growth potential. Moreover, they should possess a good understanding of the industry and the companies they are investing in.
Comparing trading and investing strategies
While active trading and investing can be more rewarding than passive investing, it also comes with a higher level of risk. Traders who are not well-versed in market analysis and trading may find themselves making poor decisions that could result in significant losses. This can be due to poor stock selection or timing. It’s essential to have a clear strategy and to be disciplined in executing that strategy to achieve success in active trading. The table below summarizes some of the rewards and risks associated with the different strategies.
| Strategy | Trading Timeframe | Rewards (Pros) | Risks (Cons) |
|---|---|---|---|
| Day trading | Hours | – Opportunity for substantial profits in a short amount of time – High level of excitement and challenge for traders – Positions are not held overnight, minimizing the impact of negative news or events | – Very risky and requires a significant amount of time and effort to monitor the market closely – High brokerage fees associated with day trading – Higher taxes on profits due to short trading timeframe – Inexperienced traders may incur significant losses due to their lack of knowledge and skill – Intense nature can lead to high levels of stress and burnout |
| Swing trading | Days to weeks | – Potential for higher returns compared to passive investing – More hands-on approach than passive investing, but less intensive than day trading – Positions are held for a few days to a few weeks, allowing for larger price movements to be captured – Does not require constant monitoring of the markets | – Still requires a significant amount of time and effort to analyze market trends and make trading decisions – Higher risk compared to passive investing due to the potential for large price movements – Traders may miss out on long-term gains that come with holding stocks for a longer period – Fees associated with frequent buying and selling of stocks can add up over time |
| Value investing | Years to decades | – Can lead to high returns through investing in undervalued stocks – Potential for lower downside risk by investing with a margin of safety – Focus on long-term performance can lead to more stable returns over time – Emphasizes fundamentals and intrinsic value of a company rather than short-term market trends | – Potential for prolonged periods of underperformance in a volatile market – Limited diversification due to the focus on a small number of undervalued stocks – Requires extensive research and analysis, which can be time-consuming and difficult – Difficulty in accurately identifying undervalued stocks and assessing intrinsic value |
| Growth investing | Years to decades | – Potential for high returns through investing in rapidly growing companies – Diversification opportunities with a focus on growth industries and sectors – Provides exposure to innovative companies that can disrupt and transform industries – Can offer liquidity and the potential for shorter-term gains – Emphasizes growth potential and future earnings prospects | – High volatility and risk due to investing in high-growth companies – Can be difficult to accurately identify and evaluate companies with true growth potential – Greater sensitivity to market fluctuations and investor sentiment – Often requires a longer-term investment horizon to realize the full potential of growth companies – Can be more expensive to invest in with higher price-to-earnings (P/E) ratios and other valuation metrics |
| Dividend investing | Years to decades | – Can provide a steady stream of passive income through dividend payouts – Offers a potentially lower-risk investment strategy due to the focus on established, profitable companies – Emphasizes a company’s ability to generate cash flow, which can provide a measure of safety for investors – Provides an opportunity to reinvest dividends and compound returns over time | – Companies may reduce or suspend dividend payments during economic downturns or other challenges – Dividend payouts may limit a company’s ability to reinvest in growth opportunities or pay down debt – Can be more heavily weighted towards certain sectors or industries, limiting diversification – Companies with high dividend yields may be viewed as “value traps” and not actually represent good value |
Combination trading strategies
Combination strategies can also be employed based on your goals. For example, dividend growth investing is a popular choice for investors who aim to receive income from dividends that increase over time. The aim is to look for companies that have a consistent dividend growth rate. This, combined with reinvesting the dividends, is a popular strategy to accelerate growth in the value of a portfolio. Reinvesting dividends is a common strategy during the accumulation phase when income isn’t needed immediately.
How to manage risk with active trading
Active trading and investing comes with higher risks, so it’s important to manage risk effectively. Some common methods to manage risk and minimize losses include:
- Diversification is a common technique that involves investing in a variety of stocks to spread risk. For example, an investor may hold stocks in different sectors or industries, rather than putting all their money into a single stock.
- Stop-loss orders are a tool that can limit potential losses by automatically selling a stock if it falls below a predetermined price.
- Position sizing is a technique that involves determining the appropriate size of each investment based on risk and reward. For example, an investor may limit their exposure to any one stock to no more than 5% of their portfolio.
The psychology of active investing
Active investing requires discipline and emotional control. Investors need to be aware of common behavioral biases such as fear and greed. These behaviours can lead to poor investment decisions. They can overcome these biases by setting investment goals, sticking to a trading plan, and avoiding emotional decisions. For example, an investor may set a goal of generating a certain percentage of returns each year and may only make trades that align with their overall strategy.
For general information on how we view money and wealth, “The Psychology of Money: Timeless lessons on wealth, greed, and happiness” by Morgan Housel (Link*) is an insightful and thought-provoking read. Housel explores the complex relationship between money, happiness, and personal values. His writing is engaging, and the book offers valuable lessons for anyone looking to develop a healthier and more mindful approach to money management.
Choosing a broker
Choosing the right broker is critical for active investors. Brokers offer different trading platforms, research tools, and commission rates. Some brokers also offer advanced features such as real-time data, charting tools, and customizable trading algorithms. It’s important for investors to find a broker that offers the tools and resources needed to execute their strategy effectively. For example, an investor may choose a broker that offers low commissions and advanced research tools.
Online brokers are also common. Many banks offer brokerage services, and a number of low- or no-fee brokerage services are becoming popular. These brokerage services include various tools and resources, which are available to help analyze company fundamentals and stock charts with a wide selection of indicators to help with trading decisions.
Final thoughts
Active stock market trading and investing requires a great deal of research, knowledge, and time. It is essential to have a systematic approach to stock selection and to stay informed about the companies you are currently or considering investing in. It’s always important to have a well-thought-out strategy in place and to be aware of the risks before starting. The strategy should include a combination of both fundamental and technical analysis to improve the chances of success.
By developing a sound strategy, managing risk effectively, and staying disciplined, investors can potentially generate higher returns in the market. However, it’s important to remember that active trading and investing is not suitable for everyone and comes with higher risks than passive investing. Investors should carefully consider their goals, risk tolerance, and time horizon before embarking on an active strategy.
More resources on actively trading and investing in stocks for wealth building
The following books provide more detailed information on the topics covered in this article. Feel free to browse through this list and support the site by making a purchase at one of our affiliate partners. Please read our affiliate links disclosure for more information. Note: The links below will open in a new browser tab or window.
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- Rule #1 by Phil Town Link*
- A Beginner’s Guide to the Stock Market by Matthew R. Kratter Link*
- Buffett’s 2-Step Stock Market Strategy: Know When to Buy A Stock, Become a Millionaire, Get The Highest Returns by Danial Jiwani Link*
- Investing QuickStart Guide: The Simplified Beginner’s Guide to Successfully Navigating the Stock Market, Growing Your Wealth & Creating a Secure Financial Future by Ted D. Snow CFP MBA Link*
- The Neatest Little Guide to Stock Market Investing: Fifth Edition by Jason Kelly Link*
- Dividend Investing Made Easy by Matthew R. Kratter Link*
- How to Day Trade for a Living: A Beginner’s Guide to Trading Tools and Tactics, Money Management, Discipline and Trading Psychology: 1 by Dr Andrew Aziz Link*
- Advanced Techniques in Day Trading: A Practical Guide to High Probability Strategies and Methods: 2 by Dr Andrew Aziz Link*
- How To Swing Trade: A Beginner’s Guide to Trading Tools, Money Management, Rules, Routines and Strategies of a Swing Trader by Brian Pezim Link*
- Trading Strategies: Day Trading + Swing Trading. A Beginner’s Guide to Trading with Easy and Replicable Strategies to Maximize Your Profit. How to Use Tools, Techniques, Risk Management, and Mindset by Mark Swing Link*
- The Psychology of Money: Timeless lessons on wealth, greed, and happiness by Morgan Housel Link*
(*) This site contains affiliate links to products. We may receive a commission for purchases made through these links at no extra cost to you. Please read our affiliate links disclosure for more information.
