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The Art of Day Trading

The Basics

So, you're interested in day trading? In day trading, the amount of time which you hold a stock is drastically different from traditional, long term stock trading, but the types of orders used are still the same.

First though, one must understand what happens each time a stock is bought or sold. John Visscher, a partner in Holloway Wealth Management, makes it clear that "each time a stock is sold their must be a buyer and a seller." The price that the buyer is willing to pay is called the "bid". The price at which the owner is willing to sell it is called the "ask".

Insights from an Expert

John Visscher, a partner with Holloway Financial Management in Gainesville, FLA, discusses who the stock market is for. He talks about how each investor is unique and should be investor their money based on their own personal game plan. Visscher has been studying and operating in the financial services community for more than 20 years. One of his most important pieces of advice is "to buy in what you know."

Various Types of Trades

The ways in which these stocks are bought and sold by individual investors is very unique, and very helpful and important for day traders. The following are various ways stocks are bought and sold:

-market order: "A market order is an order to buy or sell a stock immediately at the best available current price; no price can be specified in this order," according to Scottrade.com's knowledge center. Such an order ensures that the stock will be sold, but it cannot guarantee what price the stock will be sold at.

-limit order: This type of order is defined as "an order to buy or sell a set number of shares at a specified price or better," according to Scottrade.com. This means that your stock will not be sold until the market price meets or exceeds the price you set.

Conversely, when buying with a limit order, the transaction will not be completed until the stock price meets or drops below the price you set. Also, special restrictions can be put on this order like AON (all or none, meaning all of the shares that were specified must be bought or sold as a total unit; they cannot be sold off piece meal). Another restriction is GTC (good 'til cancelled) which means that the order will be left open indefinitely until it is cancelled.

-stop orders: "Stop orders are an order to buy or sell a security when its price reaches or surpasses a particular point…limiting the investor's loss or locking in his or her profit," according to Scottrade.com. The key difference between a stop order and a market order is that a market order immediately takes the current ask price when buying a stock, but a stop order's price--when buying a stock--always sits above the ask price for that stock.

The caveat with a stop order is that once the ask price reaches the stop price which you specified, there is no guarantee that you will buy that stock for the price you specified (a limit order would insure you receive the specified price). Once the specified price is reached, the stop order becomes a market order. If the sale is completed slowly and the stock's price shifts upward, the investor will pay far more for the stock than they had planned.

-trailing stop: A trade order set at a certain percentage or dollar decimal spread away from the market price. As the market price changes, your stop price changes accordingly. In effect, your stop price 'trails,' or follows, the market price," according to Scottrade.com.

Therefore, if you enter a stop order to sell a stock, your sale price will trail the market price by the percentage which you entered. As the price continues to increase--thus increasing your profit--your price will continue to trail, but once the stock price ceases to increase and begins to decrease, the price you entered will remain steady and eventually collide with the market price, and your stop order will sell your stock. The converse happens when you buy a stock--the price you set hovers just above the stock price and trails it as it falls, but it eventually collides with it when the market price increases.

-selling short: This is when an investor buys in on a stock position because they believe the stock price will drop. Initially, what the investor technically does is sell a certain number of shares "short" on the open market.

But he has not yet purchased these shares. Because he assumes the price will fall and he has already sold them, he waits for the price of that stock to drop. Once it has sufficiently dropped; he "buys to cover" which means that the investor actually purchases the stock now. This new lower price is the price which the stock is actually bought in at, and the initial, higher price where he made the short sale was the price he sold at. Thus, the trade was done in reverse order, but the principles are still the same. The difference between the price where he bought in, the "buy to cover" (the second transaction), minus the price at which he sold, the "short sale" (the first transaction) creates his profit.

Source of definitions Scottrade.com
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Copyright © 2009 Matthew R. Beaton. All rights reserved