Active Investing, Definition and Explanation
Active investing is when a longer-term trader seeks to profit by buying and selling assets within their portfolio when they feel market conditions favor such an action. This may include making a few buy and sell transactions per year in a small portfolio, or it may include many buy and sell transactions within a larger portfolio. Investors may also choose to have someone else do the trading for them, in this case they can still choose whether the person managing their active investments to take an active or passive approach.
To understand active investing, compare an active investor to a short-term trader and passive investor, as an active investor falls in-between these two trader types.
A passive investor typically buys assets to hold for a long term period of time, and is not particularly concerned with the monthly, or even yearly, ups and downs of the market. A short-term trader looks to capture profit opportunities on the short-term fluctuations (minute, hourly, daily, weekly, monthly) that occur in financial assets on a regular basis.
The active investor is sandwiched between these two trader types. The active investor is seeking longer-term opportunities but believes they can anticipate good times to buy and sell assets within their portfolio. With multiple assets in the portfolio moving in different ways and in different directions, investors trying to maximize returns can end up making lots of trades (active).
Active Investment Methods
Active investors use fundamental and technical analysis to help make trading decisions. They may also use statistics and seasonality.
Active investors typically have an entry and exit plan. This is what makes them active. They attempt to buy when prices are at favorable levels, and then sell when:
- Prices reach a price target they are happy with
- or, when prices start to fall again (based on a some sort of strategy or indicator)
- or, when they anticipate that the price could struggle to move higher.
After selling the asset the active investor then uses the proceeds to buy another asset that is a trading at a favorable entry price.
Active investors typically buy individual stocks and assets, creating a portfolio that way, as opposed to buying a broad-based index ETF or mutual index fund.
Pros and Cons of Active Investing
The main allure of active investing is the potential for higher returns, when compared to a passive approach. Few active investors are able to consistently beat the market returns of passive investors in that asset category though. For example, stock investors have a hard time beating the S&P 500 index returns (what passive investors might invest in) on a consistent basis over many years.
Part of the reason active investors tend to not get the returns they expect is because more trades means more commissions and trading fees. Also, active investing is not easy. In hindsight it is easy to spot big winners. With so many investments available though, finding the next big winners–and then trading them profitably–is a much more difficult task than most investors realize.
That said, there are strategies which can produce great active investing returns. See the further readings below for more details.
Further Reading on Active Investing
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