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What to Know About Active Trading

“Most people are active in the way they earn income and passive in the way they invest, which statistically is a good thing,” says Matthew Chancey, CFP. He explains that to be an active investor, “you need a higher appetite for risk and stronger emotional resilience than what investor sentiment surveys suggest passive investors typically have.”

Active trading is often promoted as a way to achieve higher returns by capitalizing on short-term market movements and price fluctuations. While this can be true, it’s essential to understand that active trading is a high-risk, high-reward strategy that demands a significant amount of time, effort, and expertise. Chancey advises that successful traders “must learn to let winners run, limit losses, properly position size, hedge when possible, learn quickly, and have a short memory—all simultaneously.”

Pros of Active Trading

There are compelling reasons why a savvy investor might prefer active trading over more passive strategies:

  1. Potential for Higher Returns: Active traders aim to exploit market inefficiencies and price movements, potentially generating higher returns than passive investing strategies.
  2. Flexibility: Active traders can quickly adapt to changing market conditions and adjust their positions accordingly.
  3. Control: Active trading allows investors to have more control over their investment decisions and timing.

Cons of Active Trading

Despite its potential for higher returns, active trading carries significant risks and drawbacks:

  1. High Risk: Active trading exposes investors to increased market volatility and the potential for significant losses if trades go against them.
  2. Time and Effort Intensive: Active trading requires constant monitoring of the markets, analyzing financial data, and making frequent buy and sell decisions. It’s challenging even for professional traders to consistently outperform the overall market over the long term.
  3. Emotional Stress: The fast-paced nature of active trading can lead to emotional stress and decision-making influenced by fear, greed, or overconfidence.
  4. Higher Transaction Costs: Frequent trading incurs higher brokerage fees and commissions, which can eat into potential profits.

The Bottom Line

“Having the skill to be an active investor is one thing, but having the emotional fortitude is something else that most people lack. Without both,” Chancey explains, “the odds of active trading working out in the long term are slim to none.” For most individual investors, passive investing strategies, such as index funds or exchange-traded funds (ETFs), are often more suitable. These strategies aim to track the performance of a specific market index or sector, rather than trying to beat the market through active trading.

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