Types of Technical Trading: Scalping, Day, Momentum, Swing, and Position Trading

Did someone ever tell you that day trading was risky or that swing trading was the best strategy to use? You probably haven’t even heard of scalping, or micro-trading. How about trading on momentum or holding a bit longer and becoming a position trader? We will cover all of these different types of trading, what they are and when they should be used so we can determine what type of trader you are or will become.

There are five main types of trading that technical traders can utilize. We’re talking about time frames from between seconds or minutes (for scalping) to weeks and months (for position trading) and everything in between. A successful technical trader should at least be proficient in several different strategies, but every trader should specialize in one particular strategy and master it. This is all dependent on 1) your personality 2) your timeframe and tolerance for risk, and 3) the current market environment. All three will determine what type of trading you will use to successfully profit in today’s market environment.

First, let me describe each type of trading in full detail before we determine what’s appropriate for you. You can’t be what you don’t know!

Scalping

Scalping (or micro-trading) is all about taking very small profits, repeatedly. Scalpers believe that stocks go in a certain direction, even for a little bit. They also believe that when you trade, you can avoid unfavorable events. Even though scalping may not be suitable for the ordinary public trader, it’s important to know that scalpers provide liquidity throughout the day. Typically, trades last between seconds to minutes, so given the volume, it is not surprising that scalpers amass the most transaction fees. Unless you have Level II quotes and are able to trade rapidly without delay, then I recommend beginners not to try scalping as a beginner. This is an expert skill because it is easier to take a larger loss that will wipe out the entire day’s gains. The biggest benefit: If done correctly, these small profits will add up.

Day Trading

Day trading is a style that most people are aware of. This type of trading received a negative reputation after the NASDAQ collapse in 2001, but that doesn’t mean that day trading is “bad” or “too risky”. Those statements are untrue, and are only true for people who did not learn how to properly day trade and got burned! Day trading is all about buying and selling stocks on the same day and you are not holding positions overnight. Comparing day trading to scalping, this particular style calls for holding stocks for minutes to hours vs. seconds to minutes. Just like day trading, this style requires mental and physical stamina and speed and execution is extremely important. Because of the short duration of trades, there is little room for error. Day traders even have their own set of tax rules by the IRS. The biggest benefit: no overnight risk! Especially in this turbulent environment, holding overnight poses serious threats to a trader’s portfolio. Having zero exposure at night gives traders much needed peace of mind.

Both rapid-fire styles of trading require traders to possess strong discipline, the time and ability to learn how to rapidly trade, a tested and profitable strategy, and enough capital to withstand sudden and enormous draw downs (losses). All four “requirements” make up to the top 10 list of the biggest mistakes a trader can make, and I will cover that topic in a future article.

Next, we arrive at two types of trading that take advantage of short-term trends and they are momentum and swing trading. Both are not as rapid as Micro and Day trading, but that doesn’t make these strategies any less profitable. In fact, these two are my personal favorites and make up my core strategy for my own trading activities.

Momentum Trading

Momentum trading is all about identifying a stock that’s breaking out and you “jumping on the wagon” to capture as much of the momentum on the way up as possible. The way this works is that you get in at the very beginning of a trend and you allow other buyers who identify the trend to provide the fuel to lift the stock higher. Let’s take Aetna (AET) as an example:

Aetna (NYSE: AET)

Notice how the stock is supported by additional buying after more and more traders realize that this stock is going to explode? You want to get in right at the very beginning of that trend. You might ask, “How do I get in that early?” In an entirely separate article I will cover the topic of how to trade breakouts. The typical time frame for momentum trading is from several hours to several days. Although momentum trading does carry overnight risk and day trading or scalping do not, there’s a possibility that there is enough force for the stock to gap up higher the next day. No risk, no reward.

Swing Trading

Swing Trading is the art of capturing the short-term trend. This style and position trading are the only two types of trading where a person with a full-time job can still consistently trade well part-time. Since the holding period is several days, intra day moves will not affect the swing trader as much as it would for a day trader. Typical holding periods for a swing trade is between 3-7 days. Let’s take a look at Natus Medical (BABY):

Natus Medical (NASDAQ: BABY)

Swing trading is best used when the market or stock is in a neutral trading range, meaning the market isn’t going anywhere but up and down without much price progress. In BABY, we can see that swing trading is effective if a trader wants to take advantage of the ups and downs of this range. You’ll notice that long-term position trading (covered next) or momentum trading will not work in this type of environment but that doesn’t mean you cannot make a profit as you can see above. Use swing trading when the market or a particular stock is going nowhere.

Position Trading

Position Traders hold stocks for weeks or months. This style of trading is synonymous with “trend following”.  The only reason to become a position trader is if you anticipate the current trend to continue for a much longer term than a momentum or swing trade. Let’s look at Alpha Natural Resources (ANR):

Alpha Natural Resources (NYSE: ANR)

A position trader would have bought on the way up and sold when the trend changed which is approximately when ANR could not make a new high. The position trader is not limited to only buying and he or she can also sell short. In each instance, the holding periods are for several weeks or months. Position trading gives traders a lot of freedom for those who cannot trade frequently. As you can see, profit potential is not diminished and position traders can make considerable gains. In ANR’s case, over 100% going long and over 100% going short!

Now that you’re aware of the different strategies that are available, I encourage you to explore yourself now. What I mean is as yourself, “What type of trader am I”? Here are some other questions to ask:

• Am I more short-term or long-term oriented?
• How much time do I have during the day to trade? Do I work full-time?
• Am I patient and able to wait, or do I need to see results quickly?

The answers to these questions will help you define who you are as a trader. I’ve seen many traders fail because they were implementing strategies that did not fit their personality. Let me give you an example: It is very difficult for a primary day trader to become a position holder and for a position holder to become a day trader. There is a conflict, and that is why many traders fail. That’s not what I want to see from each of you, so let’s take this time to figure out who you are.

• If you answered long-term, you should stick to swing and position trading.
• If you answer short-term, you can scalp, day trade, momentum trade, or swing trade.
• If you have a full-time job, you should use swing and position trading.
• If you have a lot of time, you can do anything you want!
• If you’re patient, you can implement longer-term strategies and if you prefer a dynamic, fast-paced environment, then you can implement shorter-term strategies.

I cannot fully or accurately answer the above questions for you. It’s something that only you know.

Finally, the current market environment will greatly influence what type of trading is appropriate. This is why I encourage traders to not only master a specific style, but also be proficient in others. For example, if you’re a day trader, it pays to learn how to swing trade, or if you’re a position trader, you might want to learn how to momentum trade.

Given the current market environment, as a position, swing, and momentum trader, I had to shift my strategies to include day trading as well. Ever since I lost faith in the free-market system, it became especially risky to hold positions overnight. If you’re trading or managing other people’s money, you must take steps to reduce that risk. The best way is to shift your strategy to adapt to the current market environment but also make sure that it’s within your personal parameters. If you’re in any doubt, stay in cash. Standing aside is considered a defensive position and there’s nothing wrong with waiting for an opportunity.

Have you read about hedge funds and mutual funds losing 20%, 30%, even 50% this year? They did not adapt to the current market environment and now they’re paying for it. No one said trading was easy, but it’s easier if you watch and listen to what the market is trying to tell you. Find your strategy, and you’ll avoid what the “pros” are going through right now.