Saturday, September 11, 2010

Day Trade, Swing Trade, Momentum Trade? Time Frames for Stock Traders

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.
All Rights Reserved

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The Gambler said...

A lot of money for a little while or a little money for a lot of while. There are those who just must count their money while still sitting at the table. Also beware of those trading groups who simultaneously hit at the open then later leave all at once. You can hitch a ride but you gotta jump out the door to get out. Just look for the likely targets and then a huge spike.
Somewhere near a river is an old railroad house. Somewhere right across from where arrows once shot they say gambling once happened. In fact while tearing down a structure out back one guy mentioned his grandad once lost his home playing cards. What's this we wondered..a completely boxed in space about 6 ft by 4 up in the attic of this thing? Why would anyone build..oh OK. What you really need in the market is something like that box. Approx 1920 until now, you can still find broken whiskey bottles after it rains. Guaranteed none of this stuff happened after the Great Depression because that's when Grandma bought it.

Anonymous said...

Swing trading is find in a stable market environment, however , with today's market volitility holding overnight can be suicide for one's
trading account.No thanks !I'll close at the end of the day !

Bill Kraft, said...

Interesting ? Gambler. Thanks for writing.
Bill Kraft

Bill Kraft, said...

The problem, of course, Tony is that you will always cut your profits.
Bill Kraft

Michael said...

Thanks again for your articles. I had a question about returns. What would you say should be the average percentage return for a day trading account monthly. I know that there are many variables. Assuming that the trader uses tight stops and some discipline what would be a good goal to set as a new trader and what in your experience is reality in that first year. I was thinking somewhere in the neighborhood of 2% monthly. Thanks again.

Bill Kraft, said...

Wow, Michael, that question is almost impossible to answer because there are an extraordinary number of variables. Unfortunately, most day traders lose so statistically the answer may be a negative. Of course, on the other side of the equation, a few have made quite a lot. Anything I say would only be a wild guess. I believe that one way to attempt to approximate an answer for yourself would be to paper trade for a few months before putting cash at risk and see just how you do. Of course it is important to remember that real money trading is different from paper trading in that money inevitably brings emotion to the table. Sorry I can't give you the kind of answer you are looking for but I have no basis for providing anything close to an accurate answer. Thanks for writing.
Bill Kraft

Steve Rison said...

Thank you, Bill, for taking up the subject of time frames. I appreciate that time frames for trading will vary, depending on market conditions and the specifics of a particular trade. It is these that will dictate the trading strategy, and the time frame for it to play out.

Another important question for me that is related to trading strategy is this: what trading strategies can be used successfully that are based on the closing price at the end of the day (I don't have time to monitor prices throughout the day)? I realize that stops can help to minimize the need for constant monitoring. More particularly, living in Canada means I must use a Canadian brokerage, and they don't accept stops on option trades (at least my broker doesn't - TD Waterhouse). I guess what I'm really asking is, should I give up on option trading if I can't use stops and I can't continually monitor the markets, or are there some option trading situations where I could use a trading strategy based on closing prices, for a reasonable chance at trading success.
I would guess that a general answer to this question is - the farther out the option expiry date, the less daily price fluctuations matter, and there are trading strategies that can work with this. But then the corollary to this is that the farther out the option expiry date, the higher the cost of the option. Always these trade-offs.
I suspect there is no good general answer to my question, that it really depends on the specific circumstances of each particular trade. Probably the best answer is to find a Canadian brokerage that accepts stop orders on option trades, if there is one.

Thank you so much for your insights about trading.

Steve R

Michael said...

Bill thanks for the comment. One thing that bothers me which I hear all the time is how high the failure rate is among traders. I hear fairly consistently the percentage is 90 to 95%. How in the world would anyone be able to get a fair rate on failure on such a independent occupation. I don't doubt the the failure rate is very high, but it seems to me that this percentage rate of 90% has been used so much by bloggers and so called experienced traders that now it is acceptable to throw out these numbers without backing them up. I may be completely wrong with my assessment. Would you please correct me if I am. Thanks again.

Bill Kraft, said...

Hi Steve R and thanks for writing. I agree the best solution is to change to a broker that permits stops on options such as contingent orders where one may set up an option exit based upon the price of the stock. Certain strategies such as debit spreads ordinarily require less monitoring particularly if entered with relatively long term expirations such as LEAPS. As you may already know I often use these in my Option Trader subscription plays. Where there is a vertical spread while one leg is gaining the other is often losing and vice versa. Of course that is an oversimplification meant only to suggest some further deeper study. I hope it helps at least a little.
Bill Kraft

Bill Kraft, said...

Hi Michael. I do not know how high the actual failure rate is; only that it is evidently greater than 50% of traders and reputedly much higher for day traders.
Bill Kraft