Last weekend a subscriber wrote on the blog asking about the differences in various time frames of traders and how it might affect strategies. I really appreciate the question and consider it quite insightful. As I thought about writing this article to attempt to provide some answers it occurred to me that the subject is complex. More complex than I, at least, had considered at first. This article, therefore, is not intended to be comprehensive but rather to take a look at some basics and encourage some thought on the part of interested traders.
At the opposite extremes of the time continuum of trading are the day traders and the buy and hold advocates. In between the extremes are the swing traders and trend traders. I realize that there can be overlap, particularly with swing traders and trend traders and trend traders to some extent with those who consider themselves buy and hold investors. From my personal point of view I do not favor day trading or pure buy and hold investing. Each of these time frames has serious drawbacks in my estimation.
As defined by Wikipedia, the free encyclopedia: "Daytrading refers to the practice of buying and selling financial instruments within the same trading day such that all positions are usually closed before the market close for the trading day." The first problem with daytrading is that an overwhelming number of retail day traders lose. I suspect there are a number of reasons for that fact. One reason is that commissions, even when small per trade, are accumulated by the necessity of trading in and out with a relatively high frequency. Another is that, of necessity, the day trader cuts his profits. Since the day trader does not hold a position overnight he will never experience the profit of an opening gap up (of course, he won't ever lose the opening gap down, but that loss can at least be cut by a longer term trader with a stop or a quick trigger). One of the most important factors in most successful trading is to let profits run and when one does not permit that to happen because of the necessity of closing every trade every day, it seems like an edge is lost. In addition, in terms of strategies the day trader seemingly has a lesser arsenal. For example, it would be difficult to achieve profits with an option credit spread that is often dependent on the passage of time to succeed. Even the sale of a naked put would not be as likely for the day trader since the play would not profit absent a sharp upside move in the underlying stock during the specific day the trade was in place. I don't mean it couldn't be done, but it certainly does not seem to be a strategy of choice for the day trader. In fact, any strategy that is dependent in substantial part upon the passage of time must likely be abandoned by the day trader.
At the other end of the spectrum is the pure buy and hold investor. Anyone who has read my writings or heard me speak on the subject knows that I am not particularly enamored with pure buy and hold as a strategy. The question I always ask the buy and hold advocate is: "Hold until when? Death?" That's great for the heirs, but I'm not so sure it is so wonderful for the investor. Holding can involve a lot of pain and quite regularly involves hanging on to positions as they plummet, sometimes to zero. A quick look at the long term charts for the major averages over the past 10 or 11 years shows that the buy and hold investor currently would be near or just below the levels in 1999 to 2001 and 2004-05. For some significant periods from 2001 through 2003 and from late 2008 until nearly the end of 2009 the holder of the Dow 30 average would have seen sharp deterioration in portfolio value. What if he needed the money during those times? In short, having no exit seems dangerous to me and that is what buy and hold means.
Personally, I favor swing trading and trend trading over day trading and buy and hold. In each of those methods, the holding period is not determined by the end of the day (as in day trading) or is completely undefined except by death (as in buy and hold). Swing traders tend to hold positions from a few days to a few weeks where, according to Wikipedia, at least, the assets are "...repeatedly bought or sold at or near the end of an up or down price swing caused by price volatility." While that seems like an oversimplification, the point is that the swing trader enters and exits based upon price activity. The trend trader is generally thought to have a longer time horizon but that is also determined by price activity. The trend trader attempts to ride the trend as long as it exists and exits when it is broken perhaps to then enter a position that will profit in the opposite direction. Swing traders and trend traders are able to avail themselves of many option strategies in addition to the strategy of buying the stock or selling it short. They may buy directional options, enter credit spreads, debit spreads, butterflies, or iron condors. They may use vertical, horizontal, diagonal, and/or calendar spreads and in each case can (and in my estimation should) have an exit strategy specific to the individual trade.
In any event all the above are just a few thoughts to scratch the surface of the relationship of time intervals to trading. Hopefully they will provoke other thoughts with you.
by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
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