To trade on the stock markets, one needs to follow a special plan – a trading strategy.
What Is a Trading Strategy?
It is a set of rules for trading securities or futures. Trading strategies can be manual and automatic. A manual TS consists of a few simple conditions and instructions that can be executed manually. An automatic TS can contain very complex algorithms that are executed by a computer.
Most trading systems rely on either fundamental analysis or technical analysis and their indicators to generate the entry and exit signals. In addition, one must define the money management rules. Interestingly, the wrong money management rules can render a basically profitable strategy unprofitable, and not vice versa.
Trading Strategy has several components: the choice of trading instruments, the search for the transaction entry and exit points, risk management, the choice of position size, etc. Accordingly, the classification can be carried out according to various criteria.
Types of Trading Strategies
There are the following types:
Following the Trend
One of the first recommendations that a beginner trader receives is not to go against the main trend. Making deals in the direction of the market movement significantly increases the likelihood of their positive outcome. Obviously, to follow the trend, you need to select a stock in which a strong directional movement has begun. Then you should find an entry point with an acceptable ratio of risk and profit potential.
The opposite approach is also possible - to open trades against the trend if there is a reason to believe that the market is ready to turn around. The disadvantage of this method is the low percentage of successful transactions, because, according to statistics, the probability of continuing a trend is 80%. But some traders are willing to take increased risks for the sake of increasing the profit potential. By entering a confirmed trend, you miss a part of the movement, and the price may turn around at any time. Trend reversal allows you to enter the movement at the very beginning and thus gain an advantage over other traders.
It is a specific type of day trading. A scalper makes dozens or even hundreds of transactions per day, quickly closing each of them as soon as there is even a tiny profit. Often, scalpers earn just due to the bid-ask spread. Trading with such a strategy requires volatile and highly liquid stocks, regardless of whether they have a directional movement.
Breakout trading is one of the most popular approaches to opening a trade. Breakout strategies can bring good and fast profits by using the explosive potential of directional motion. An important condition for breakout trading is the presence of a strong bullish or bearish trend and an important level of support or resistance. The increase in volumes at the moment of breaking through the level is a confirmation signal and indicates that other market participants are ready to go in this direction with you. Having noticed the breakout, new buyers enter the stock (in the case of a bearish breakdown, the short sellers), ensuring that the strong movement is continued.
The trade opens with a gap when important news comes out before the market opens or an event occurs that could affect the price of the stock. As a rule, on such a day, the stock is trading at an increased volume and can pass several times more than usual. This strategy is based on the assumption of whether the price will go in the direction of closing the gap or continuing the movement. This method is interesting for day traders because it is quite simple to find stocks with gaps, and increased activity in them is almost guaranteed.
This strategy is typically used by experienced traders. They use the one-, two-, five-, and fifteen-minute time frames to enter a position. Competent intraday trading is characterized by accurate market entry and the absence of position transfer overnight. Often, in this trading strategy, positions are closed even before clearing, if the risk management system requires that.
Day trading is suitable for most traders because it is much easier to the scalp. It also allows making deals at an easy pace and at the same time gain experience at the stock exchange.
Only a few of those who initially started trading in financial markets reach this style of trading. The frequency of making trades here is significantly lower and the number of transactions varies from one per day to one per week. Accordingly, the working time frames here are 30 minutes, 1 hour, and 4 hours.
Swing trading uses the classic formations that only appear on higher time frames. The considered trading strategy includes various dividend histories in stocks. Specifically, the purchase of shares under the dividend cut-off and various ideas related to the release of news for a particular company. This style of trading is best suited for traders who already have trading experience and who do not have the time or desire to trade actively.
There are the following types of investments:
short-term - three months to one year,
medium-term - six months to 2-3 years,
long-term - over 3 years.
This strategy is typically used by large investors and funds. However, a considerable part of private traders also uses similar investment trading strategies, especially the short-term and medium-term ones.
For this type of trading, especially when holding a position for half a year, it is typical to use fundamental analysis (unlike all previous methods, where the main type of analysis is technical). In investment strategies, the entry points often wait from several weeks to several years, depending on the tools used. With competent trading, investing in the overwhelming majority of cases ultimately brings the greatest return.
A trading strategy is a set of rules that one follows in order to trade futures and securities. To develop a TS, the trader should choose the trading instruments, search for the transaction entry and exit points, manage risks, choose the position size, etc.