What’s with all the labels?
When diving into all of the literature online regarding stock market investing, there are always terms being thrown around to describe traders. High frequency trading (HFT), day trading, and swing trading are without a doubt some of the most popular vocabulary terms used to label individual traders.
High Frequency Trading (HFT)
High frequency trading has blossomed into the most common form of trading on the market nowadays. HFT is known to comprise 60% to 70% of the market trading on any given day. This means that individual traders are competing against the high frequency traders. So, what is a “high frequency trader”? Put simply, it’s a computer that trades based on a proprietary algorithm, or programmed logical pattern. Financial institutions, hedge funds, and individuals design their own algorithms and run them on state-of-the-art computers. These algorithms buy and sell securities in seconds, much faster than a human day trader. These HFT’s scan the market and sift through thousands of data to make decisions. The computers that run these algorithms are often referred to as “black boxes,” or “black box trading.” They often have a direct connection with their respective stock exchange which allows for transactions to be executed with nearly no latency, as compared to trading over the Internet on a home network. Engineering an algorithm and developing a hardware infrastructure necessary to run an HFT system is expensive and out of reach for most recreational or non-professional investors.
Day trading is the act of buying and selling a stock or security within a matter of seconds, minutes, or hours. Generally, a classic day trader will not hold a given stock overnight. Day trading differs from investing in the sense that an investor is looking for his/her holding to appreciate in value over a long-term time horizon, while a day trader is looking for opportunities in the market to make a profit based on market swings or crowd psychology. Day trading is extremely risky, volatile, and keen to enormous swings in variance. Therefore, day trading should only be attempted by experienced individuals that are accustomed to market variance and have “earned their stripes” by investing in the past, or through paper trading (software that allows the user to practice trading with fake money). The Financial Industry Regulatory Authority (FINRA) has what is called the Pattern Day Trader Rule, or PDT. This stops any individual or entity from day trading (making 4 or more buy & sell orders within 5 business days) with less than $25,000 in their account. So, if you’re planning on day trading, ensure that you have plenty of capital to meet this requirement, and then some.
Swing trading is more akin to day trading than high frequency trading. Like day trading, swing trading is a popular strategy used by individuals looking to profit on short-term swings in the market based off of crowd psychology, company news, earnings, new product announcements, etc. However, swing traders do not enter and exit their positions as frequently as day traders. While a day trader may buy and sell tens of stocks a day, a swing trader may hold a certain stock for a few days to a few weeks. Swing traders are still considered short-term investors, but they are not as “busy” as day traders, meaning they sit on their holdings just a bit longer. As a result, swing trading is a way for the modest investor to trade in the short-term time horizon without being flagged by FINRA as a PDT. This comes with the benefit of not having to succumb to the $25,000 minimum account balance. Do not let this fool you, swing trading is just a risky and vulnerable to variance as day trading and high frequency trading. Swing traders should still put in the hours via paper trading and educate themselves on proper techniques and analyses before purchasing any security.