Active Trading Techniques

Day traders typically look to two sources of financial gain. They are same day "swing trading" and "playing the spread". Swing trading (or position trading) is where the trader holds the stock for a short time (usually more than a day) hoping their value will increase. An alternative is to short the stock, which is a way to profit on the stock decreasing in price, but which requires paying interest if one keeps the position open for a length of time.

Playing the spread involves buying at the Bid price and selling at the Ask price. The numerical difference between these two prices is known as the spread. The bigger the spread, the more inefficient the market for that particular stock, and the more potential for profit. This spread is the mechanism that large Wall Street firms use to make most of their money (as opposed to trade commissions) since the advent of online discount brokerages. To make the spread means to simply buy at the Bid price and sell at the Ask price. This procedure allows for profit even when the bid and ask don't move at all. This strategy has become less profitable (and popular) since stocks began trading in penny increments.

When the typical online investor places a market order to buy a stock, his broker submits this order to a market maker (MM), who then fulfills the order at the Ask price. In other words, the Ask price is the price the MM is asking for the stock. When the typical online investor places a market order to sell a stock, the broker submits the order to a MM and sells at the Bid price, i.e. what the MM is bidding for the stock.

Due to the liquidity of the modern market, orders are constantly flowing. Many times, a MM will buy a stock just to turn around and sell it to a particular broker. In fact, one of the primary purposes of the MM is to maintain liquidity in the market (among other things). Through this transaction, the MM will profit anywhere from a few cents to a whole dollar per share, in average circumstances. Over the course of a single day, a MM may fill orders for hundreds of thousands or millions of shares.

Day traders are able to capture some of the spread through buying access to Direct-Access Broker systems, rather than by trading through retail brokers. The average online investor uses a retail broker. (All of the brokerages that advertise $15, $10, or $5 commissions to the general public are retail brokers.) Through direct-access brokerage systems, day traders send their orders directly to the ECNs, instead of indirectly through brokers. ECNs put day traders on the same level as MMs.

via [ TradeBlog ]