Unlike passive investing, active investing requires constant involvement and monitoring of stocks throughout the day.
Maybe you’ve tried the passive route, and you want to get more invested in your trading. While it can be risky and expensive, it certainly has its advantages if you know what you are doing.
Our article answers the question, ‘what is active investing?’, and helps you to understand how it works. We also detail the pros and cons, as well as some common active investing strategies.
What is Active Investing?
Active investing is a hands-on investment strategy. This investment style involves the ongoing buying and selling of financial assets. As an active investor, you constantly monitor your investment activity in order to maximize returns.
The aim of active investing is to outperform the market or to beat certain sector benchmarks. Investors do this by identifying and timing profitable trade deals. This means that your investments often have short holding periods.
Understanding Active Investing
Before adopting an active investment strategy, there are some key aspects of active investing to understand.
Active investing is highly involved
As the name suggests, this investment strategy involves active oversight of your portfolios. Active investing means constant monitoring of price movements. Generally, active investors are looking to make short-term profits. This means that investors need to know the position of their stocks throughout the day.
It’s about picking individual investments
You need to be able to identify the most attractive investments at a given time. Active investing is all about deciding which individual assets you think will perform well. This will help you to outperform the market. Being up-to-date on global events and the performance of your chosen market sector will help you to make the best decisions.
Unfortunately, there is no way of being completely certain that a stock will perform well. This is where the risk factor comes in.
It aims to beat the market
The market return is based on the collective performance of all companies in it. Some companies will perform well, while others might not. The performance of all companies will provide the average market return.
The goal of active investing is to beat the average market return. You choose to invest in companies with high potential returns. This way you achieve an overall annual return that is higher than the market average.
It means more buying and selling
Active investing means that you are constantly buying and selling shares. While this requires a hands-on approach, it gives you more flexibility. You are able to take advantage of market opportunities by moving your investments between companies.
Common Active Investing Strategies
There are several different strategies that investors use when it comes to active investing. The four most common strategies include day trading, swing trading, position trading, and scalping.
Day trading is when a trader buys and sells a financial instrument within the same trading day. This means that all trade positions are closed before the market closes for the day. Investors do this to avoid unmanageable risks that might change trade prices overnight.
This trading style is most common on stock markets and Forex markets. Generally, only experienced and well-funded investors will adopt this trading style.
Swing trading is a style of trading that tries to capture short-term gains in a stock over a period of a few days to several weeks. Positions in swing trades are generally held between several days to several weeks. Stock prices oscillate most of the time which creates short-term trading opportunities. Swing traders mostly use technical analysis to look for trading opportunities.
A position trader buys an investment for the long-term with the expectation that it will increase in value. This involves keeping a position open for a long period of time. As a result, a position trader is less concerned with short-term market fluctuations. Positons are usually held for weeks or months.
Scalping is another short-term trading strategy. It focuses on the volume of trades placed, rather than individual investments. This involves short time periods between the opening and closing of a trade. The goal is to profit off of small price changes, making a fast profit off by reselling. It's essential to have a strict exit strategy when scalping. One big loss could overrule the many small gains made.
Benefits of Active Investing
There are many reasons why experienced investors choose to adopt active strategies. Here are some of the benefits of active investing.
- Risk management: Active investing allows you to adjust your portfolios to suit current market conditions. If market conditions are volatile, you are able to adjust your portfolio exposure to certain market sectors. This reduces your financial risk.
- Short-term opportunities: Stock prices move around most of the time which creates short-term trading opportunities. An active investing strategy lets you take advantage of short-term trading opportunities.
- Specific goal outcomes: Active investing allows you to meet your specific investment needs. Financial goals include retirement income, targeted returns, or portfolio diversification. Investors use active strategies when they try to deliver absolute returns. These often don't compare to a benchmark.
Downsides of Active Investing
- Cost: Active investing comes with higher account management fees. It tends to be costly due to the high number of transactions you make. The constant buying and selling of stocks mean that there will be more commission fees. Active money managers may also charge high account fees that will affect your returns.
- Minimum investment amounts: Active funds often set minimum investment thresholds for prospective investors.
Active vs. Passive: Which is better?
This is an ongoing debate amongst even the most experienced investors. Passive investing has grown in popularity over the last few years. On the other hand, many investors find that active management increases their returns.
While there are higher risks, active investment is especially helpful during periods of market stress. Market outperformance is most critical for investors during volatile periods. Active strategies will outperform in certain investing climates, and passive strategies will outperform in others. These are two different strategies that will suit different investors.
Active investing is a hands-on investment strategy that involves ongoing buying and selling. As an active investor, you need to have active oversight of your investment activity. Your goal is to maximize returns by outperforming the market average.
While there are many risks associated with this trading style, there are many benefits. Active investing allows you to be more flexible and to adapt well to market conditions.