Use Technical Analysis
You need particularanalytical techniques and tools to determine when a trend starts and when itwill likely come to an end. Technical analysis specializes in interpretingprice trends, identifying the best time to buy and sell a security with the useof charts. Unlike fundamental analysis, technical analysis sees price as anall-important factor that tells the direction a security will take in the shortterm.
Here are threeprinciples of technical analysis:
For the most part, thecurrent price of a stock already reflects the forces influencing it—such aspolitical, economic and social changes—as well as people's perception of theseevents.
Prices tend to move intrends.
History repeatsitself.
From these threeprinciples emerges a complicated discipline that designs special indicators tohelp the trader determine what will happen in the future. Indicators are waysin which price data is processed (usually by means of a calculation) in orderto clarify price patterns, which become apparent when the results of theindicator's calculation are plotted on a chart. Displayed together with plottedhistorical prices, these indicators can help the trader discern trend lines andanalyze them, reading signals emitted by the indicator in order to choose entryinto or exit from the trade. Some examples of the many different types ofindicators are moving averages, relative strength and oscillators.
Fundamental analysiscan be used to trade, but most traders are well trained and experienced in thetechniques of charting and technical analysis. It is a blend of science and artthat requires patience and dedication. Because timing is of the utmost importancein active trading, efficiency in technical analysis is a great determiner ofsuccess.
Leveraged Trading
The short termapproach of investing offers opportunities to realize capital gains not only bymeans of trend analysis, but also through short-term investing devices thatamplify potential gains given the amount invested. One of these techniques isleveraging, which is often implemented by something called margin.
Margin is simply theuse of borrowed money to make a trade. Say you had $5,000 to invest: you could,instead of simply investing this amount, open a margin account and receive anadditional, say, $5,000 to invest. This would give you a total of $10,000 withwhich to make a trade. So, if you invested in a stock that returned 25 percent,your $10,000 investment turns into $12,500. Now, when you pay back the original$5,000, you'd be left with $7,500 (we'll assume interest charges are zero),giving you a $2,500 profit or a return of 50 percent. Had you invested only$5,000, your profit would've been only $1,250. In other words, margin doubledyour return.
However, as theupside potential is exacerbated, so is the downside risk. If the aboveinvestment instead experienced a 25 percent decline, you would have suffered aloss of 50 percent, and if the investment experienced a 50 percent decline, youwould've lost 100 percent.
You may have alreadyguessed that, with leverage, a trader can lose more than the initialinvestment! As such, it is a trading tool that should be used only byexperienced traders who are skilled at the art of timing entry into and exitfrom investments. Also, since margin is borrowed money, the less time you taketo pay it back, the less interest you pay on it. If you take a long time to tryto reap profits from a trade, the cost of margin can eat into your overallreturn.
The Risks of ActiveTrading
Active trading offersthe enticing potential of above-average returns, but like almost anything elsethat's enticing, it cannot be achieved successfully without costs and risks.
The shorter timeframe to which traders devote themselves offers a vast potential, but since themarket can move fast, the trader must know how to read it and then react.Without skill in discerning signals and timing entries and exits, the tradermay not only miss opportunities but also suffer the blow of rapidlosses—especially if, as we explained above, the trader is riding on highleverage. Thus, learning to trade is both time consuming and expensive. Anyperson thinking of becoming an active trader should take this into account.
Also, the higherfrequency of transactions of active trading doesn't come for free: brokeragecommissions are placed on every trade. Since these commissions are an expense,they eat into the trader's return. Because every trade costs money, a tradermust be confident in making decisions: to achieve profits, the return of atrade must be well above the commission. If a trader is not sure of what to doand ends up trading more frequently because of blunders, the brokerage costswill add up on top of any losses.
Finally, becausesecurities are being entered and exited so often, the active trader will haveto pay taxes on any capital gains realized every year.
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