Short-term trading is more profitable, but very risky. It can last for as little as a few minutes to as long as several days. To succeed at this strategy, traders must understand the risks and the rewards of each trade. They must not only know how to spot good short-term opportunities, but also must be able to protect themselves from unexpected events. In this article, we'll explain the basics of spotting good short-term trades and show you how to make profit from them.
The Fundamentals of Short-Term Trading
Several basic concepts must be understood and mastered for successful short-term trading. These fundamentals can mean the difference between a loss and a profitable trade. Let's take a look at these vital principles.
- Recognizing Potential Scripts and Spots
- Controlling Risk
- Technical Analysis
- Buy and Sell Indicators
Principle 1: Recognizing Potential Scripts and Spots
Recognizing the right possible trade will mean that you know the difference between a good potential situation and the ones to avoid. Some basic steps must be followed to find the right trades at the right times.
Step 1 : Watch the Moving Averages
A moving average is the average price of a stock over a specific period of time. The most common time frames are 15, 20, 30, 50, 100 and 200 days.
Step 2 : Understand Overall Cycles or Pattern
Generally, the markets trade in cycles, which make it important to watch the calendar at particular times. Since 1950, most of the stock market’s gains have occurred in the November to April time frame, while during the May to October period, the averages have been relatively static.
Step 3 : Get a Sense of Market Trends
If the trend is negative, you might consider shorting and do very little buying. If the trend is positive, you may want to consider buying with very little shorting.
Controlling risk is one of the most important aspects of trading successfully. Short-term trading involves risk, so it is essential to minimize risk and maximize return. One can control the possibility of loss by setting strict stop loss and keep modifying it in regular intervals so as to ensure that the sudden falls will limit your loss or will allow you to book at least minimal profits in the right time.
Technical analysis is a process of evaluating and studying a stock or markets using previous prices and patterns to predict what will happen in the future. In short-term trading, this is an important tool to help you understand how to make profits while others are unsure. Technical analysis has become very easy with invention of various software and applications. A beginner to the stock market must take required training to use the software. Also technical analysis may go wrong in many situations like, unexpected rumors, global market downturn, and regulatory views/decisions on a particular sector or industry.
Buy and Sell Indicators
Several indicators are used to determine the right time to buy and sell. Two of the more popular ones include the relative strength index (RSI) and the stochastic oscillator. The Technical Analysis software will actually give these indicators but to understand and act on that you need to have sound knowledge of the markets.
Another tool that can help you finds good short-term trading opportunities are patterns. A pattern is a change in direction up or down in the price of stock and reflects changing expectations. Patterns can develop over several days, months or years. To study the patterns of various scripts you need to know the performance graph of the respective stock. We can also determine the patterns of a particular stock by going back to the past of the stock like how it performed after the announcement of each Central Budget or after declaring the company’s financial results.
There are primarily three types of traders/investors in the stock market :
- Day traders
- Short-term traders
Those who expect minimum 30-40% appreciation and are willing to hold between two months to a few years. They enter only long positions and usually select a scrip based on fundamental analysis. Medium-long term investors can utilize technical analysis to time their entry and profit booking better.
Day traders enter long/short trades to square up on the same day. They usually base decisions on technical analysis or at times, gut feel.
Short-term traders expect 5-20% returns within 2 days to 3 weeks. They enter long as well as short positions. These include :
a ) Position trading, where one either buys a stock and holds for the required appreciation, or sells from an existing long (or borrowed) position to cover at a lower level.
b ) Futures & options trading
The popularity of Short-term trading is on the rise due to the following reasons :
- It provides an opportunity to make substantial profits in a short period and ensures continuous rotation of capital.
- As against long-term investment, short-term trading has limited downside because of strict stop losses.
- Short-term trading has less demand on the trader’s time, while day trading requires full-time attention at the terminal. Hence, even those who pursue other professions can do short-term trading.
- One can leverage on margin in case of short-term trading in futures.
- Short-term trading in options requires smaller investment and has limited risk.
- Like every discipline, short-term trading also has its Dos and Don’ts. These are not well understood by all. This article outlines these rules, which would make short-term trading a relatively safe and satisfying experience.
Short-term trading uses many methods and tools to make money; however, you must know how to apply the tools to achieve success using this type of strategy. If you can do this, you will be able to make money in both bull and bear markets while keeping your losses at a minimum and your profits at a maximum. This is the key to mastering short-term trading.