So, how do you trade? and more importantly, how do you trade with consistent profitability? The answer is to have a sound understanding of different trading strategies that can help you tackle the ever-changing and challenging market conditions. So read on...
What Is A Trading Strategy?
A trading strategy is something that gives you a handle on the current market situation because before you can make your first trading decision, you need to have a sound understanding of the markets and how they function. (LO)A trading strategy will give you the best course of action for the current market condition. It will give you the best set of actions to take so that you can achieve the basic trading objectives,
Basic Trading Objectives
- Preserve Capital
- Minimise Risk
- Maximise Profits
So how do you achieve these basic trading objectives? You start by selecting the best trading strategy, one that suits current market conditions and your trading style and personality, dive into this detailed record of different trading strategies and select the one that feels the most promising to you...
Types Of Trading Strategies
There are two basic types of trading strategies,
- Technical Trading Strategies
- Fundamental trading Strategies
While there are merits to each one of them, I being a technical trader am qualified to speak on the former. So let's start...
Technical Analysis
This field concerns itself with the behaviour of the price of the stock, bond or commodity you might want to trade. The only way you can make profits in the markets is by creating a price differential, that is...
Sell Price >> Buy Price (period)
And focusing on this sole objective technical analysis has zeroed in on the basic elements of the above equation namely price. different technical trading strategies will try to give you a sound understanding of what the price is doing at this moment and possibly what it can do in near future.
So let me list down the different trading strategies being used widely...
- Trend Trading Strategies
- Momentum Trading Strategies
- Swing Trading Strategies
- Retracement Trading Strategies
- Positional Trading Strategies
- Intraday Trading Strategies
- Range Trading Strategies (Trading Sideways markets)
- Scalping Strategies
- Intraday Trading Strategies
- Transition Trading Strategies
- Breakouts and Breakdown Trading Strategies
- Reversal Trading Strategies
- Volatility Trading Strategies
- High Volatility Trading Strategies
- Low Volatility Trading Strategies
- Trading News and Events Strategies
- Sentiment or Social Trading Strategies
- Trading Chart Patterns
- Classical Chart Patterns
- Advanced Chart Patterns
- Elliott Wave Trading Strategies
- Harmonic Patterns Trading Strategies
- Price Action Trading Strategies
- Trading Technical Indicators
All the above trading strategies are huge topics by themselves and cannot be covered in a single blog post, but more, much much more is following, just stay tuned...
Let me now describe each one for you in a few short and sweet sentences so you can get a broad idea as to which one is more suitable for you, and pursue in greater detail...
1. Trend Trading Strategies
The most important requirement for this one is that there should be an existing trend in the market of your choice. A trend is identified by a series of subsequently higher or lower prices. If over a number of days prices keep closing higher we can call it an uptrend and vice versa.
The best strategy is to jump on the trend as early as possible, because once you miss it, you may not be able to catch it again. More often than not retail traders often chase the price up or down and enter in the trend when it is just about to change (we will encounter this in reversal trading strategies). To avoid this a trader needs to act decisively when the trend is about to begin and then manage the risks tightly when it has gone on forever.
The basic assumption for this strategy is that what is happening in the markets presently is likely to continue in the future, unfortunately, it is never so black and white...
a. Momentum Trading Strategies
First of the trend trading strategies. If you want to be successful in trading you must appreciate the fact that trends seldom continue in a single line. They have a start a middle and an end. And a whole lot in between these phases. All good trends are interspersed with small consolidations in between, where the market catches its breath.
Once the traders accept this new price level the trend begins anew. Often when the trend is young it moves at a fast speed, this is when it has the most momentum. Momentum traders look to capitalise on this phase.
They want to jump on a trend when the rate of price change is highest, these traders often will come out of their trades when the momentum starts to wane. The trend may continue but the speed decreases and that is when these traders jump out.
b. Swing Trading Strategies
Markets have a tendency to move in steps. They move up a certain distance and then consolidate, then they may resume the uptrend or turn back down and complete the next step. These swings may last from a couple of days to a few weeks and are probably the most profitable type of trading.
It gives huge rewards when compared with intraday trading and the risk is considerably lower when compared to longe term trading or investing. Also, the lower holding period makes it possible for a trader to take multiple such trades in a trading year and exploit these mini-trends to make huge profits.
c. Retracement Trading Strategies
As we saw a trend seldom continues in a straight line. Prices often stall and move sideways or go in the opposite direction of a trend for a brief period of time. Then the original trend asserts itself and the continues.
How far this retracement goes also gives us an idea of the strength of the trend. Deeper cuts indicate a weaker trend, shallow corrections indicate a stronger trend. (If you are an Elliott wave fan then the flat corrections are an example of shallow corrections and zig zags are an example of deeper corrections).
A retracement gives a trader a low-risk opportunity to jump on board an existing trend.
d. Positional Trading Strategies
As we saw in swing trading the trades lasted from a couple of days to a few weeks, positional trading can be considered as the next stage. Where the positions may be held for a few weeks to a few months. These distinctions will vary from trader to trader, but hold true in general.
Positional traders have a longer-term view on markets and are comfortable riding smaller counter trend swings to their original positions. As always the longer the holding duration greater the price differential possible and hence greater the profit potential.
The only thing a trader has to contend with in positions trading is higher risk.
e. Intraday Trading Strategies
Intraday trading as the name suggests refers to entering and exiting the trade during the same trading session. Often for smaller price differentials.
It is probably the most difficult type of trading strategy to master. But the lower initial risk (stop loss) is what attracts majority retail traders to this strategy. But as we know there is no free lunch, especially in the markets. So if you intend to master this trading strategy you need to work extra hard.
2. Range Trading Strategies (Trading Sideways markets)
As discussed previously, markets often pause between trending phases. These phases occur on all timeframes. Right from an intraday timeframe to a yearly timeframe. The best way to exploit these phases is to be nimble and curb down your expectations.
Whenever the price is moving sideways we get a fair idea about the extremes of this range. The best strategy is to expect the prices to reverse the trend at one of the extremes. some of the technical indicators (oscillators) help a great deal in handling this type of market condition.
Buy low sell high is the mantra here.
a. Scalping Strategies
When we are talking about the sideways consolidations on smallest of time frames the trading strategy used for trading them is called as scalping. Here we buy and sell quickly to capture a few ticks or points. The profit expectations are low but the number of trades may be very high. At the advent of technology, such kind of trading is often automated using computers and is called Algorithmic Trading.
This kind of trading used to happen in the pits in old days. The main obstacle to pursuing this strategy is the transaction costs associated with trading. with brokerage and taxes, this often becomes nonviable for the retail traders.
b. Intraday Trading Strategies
This strategy holds the most promise and attracts the most number of traders, especially retail traders. The biggest lure is the lower per trade risk, but what the traders often ignore is the probability of success.
The primary reason for the failure of traders with this strategy is the sheer amount of information the traders have to tackle during a days trading. From news and announcements to results to international developments to a plethora of indicators to human psychology (most important) and on and on.
It quickly becomes overwhelming to track everything and the trader gets buried under the weight of information. Chose this one carefully, incidentally, I have a perfect solution for this problem and it is called Market Generated Information. (LO)
3. Transition Trading Strategies
These strategies are seldom discussed, almost never as a separate category. But they are most widely traded ones. Also, the success rate is pathetic for obvious reasons. They serve as the best traps professional traders use to trap the retail traders like you and me.
Whenever the change is occurring the opportunity as well as the risk is the highest. To tackle this kind of situations in the markets one needs a solid foundation on which to base your trades. I faced a lot of trouble mastering this trading strategy and finally found out that if you just listen to the markets without any bias, you often get the picture correct.
a. Breakouts and Breakdown Trading Strategies
Once a sideways move is developing, we don't know when it will end and the trend will either resume or reverse. The key is patience and close observation. Often the dull sideways movement leads to boredom for the traders. Then they try to anticipate the breakouts and fail a couple of times, and then lose interest in the markets.
Right when this happens, the markets give a dynamic breakout, the momentum traders pile on and the prices move away from this consolidation quickly, often leaving you in the lurch. If you have had a similar experience (I know every trader has had one) share it in the comments section.
b. Reversal Trading Strategies
These are the places where you will find the maximum number of traders graves. This is one thing a trader needs to avoid at all cost. This area is solely for the traders with huge experience and big, big pockets.
The way the retail traders try to play this one is by keeping extremely small stop losses and hoping to catch an exact top and bottom, but it seldom happens. And the trend can continue longer than the retail traders can remain solvent.
I personally avoid catching the top and bottom, a better strategy to sit out till the markets tip their hand and then jump on to a trade.
4. Volatility Trading Strategies
Volatility in recent times has become the nemesis of the most patient of traders. Just when a trader feels that the market may move in one direction it moves in other, hitting the stop loss of the trader in the process. One remedy traders use to tackle such markets is to drop down to lower timeframes, but over a period of time, they only end confusing what their original timeframe was.
Options are the best trading vehicles to tackle the problem of volatility, but once again it is a huge subject in itself. More, much more, is coming on this topic...
a. High Volatility Trading Strategies
This might get a bit technical, but when the volatility is high it pays to be on your toes. High volatility periods are often followed by low volatility periods. Volatility is often highest when the trend change is happening.
When the prices are moving in one direction in small increments, the volatility often drops.
b. Low Volatility Trading Strategies
These are often marked by either a persistent trend in small increments or a very narrow range bound movements. The best way these periods can be used is to try and position for the increase in volatility that is coming your way.
Usually, the transition trading strategies see changes in volatility situation as well.
5. Trading News and Events Strategies
This one once again is the reason why so ma retail traders are losing money in the markets. This also includes the gurus you see on the television. More often than not these gurus end up creating the markets for the smart traders to either accumulate or distribute their holding to the masses.
The news channels are in the business of providing a reason for the news, but a trader if he has to make money often needs to buy or sell before the event is made public. Which is often not the case. The retail traders often are left to deal with the increased volatility because of the event and their stop losses are often hunted down by the smart traders.
My strategy is to avoid these news channels (more of entertainment channels) altogether. I have not watched one in more than a decade now. I am doing ok, you can too...
6. Sentiment or Social Trading Strategies
The social media revolutions did not give us unwanted status updates and too many details into people's personal lives, they also gave us an insight into what they think about the markets. At the end of the day what the traders are thinking is what decides what they will do (buy or sell) and how their actions will impact the markets.
There are complicated computer programs being run to assess what most traders are saying about the markets at any point in time and then the smart traders take decisions based on what consensus is developing.
7. Trading Chart Patterns
This is probably the oldest form of analysing the markets. When the first chart was plotted sharp traders would have plotted these patterns right away. The patterns show up because the traders behave in a certain way in certain situations. This keen study of traders behaviours is what keeps these patterns in vogue today.
The chart patterns have evolved and have taken many different shapes and sizes, let us look at a few of them.
a. Classical Chart Patterns
These are the traditional chart patterns which repeat with uncanny consistency on the price charts. When the price action is combined with volume these patterns can give some deep insights into what is happening in the markets. These patterns develop because of peculiar trader behaviour which has stood the test of time.Some of the common chart patterns are the head and shoulders, triangles, pennants, flags, wedges, rectangles, etc. Though these names may sound funny to the beginner these are very potent technical patterns and provide great opportunity to make money in the markets.
b. Advanced Chart Patterns
As traders start adopting various technical methods and start using them a sort of consensus starts building in the markets wherever the pattern starts showing on the charts. This behaviour is observed by the smart traders and they start fading the consensus. This results in what is called as a failed pattern, and that is when the need for better analysis emerges.i. Elliott Wave Trading Strategies
Ralph Nelson Elliott designed this way of analysing the markets. He observed markets similar to waves in the sea move in a specific rhythm. Three impulses (directional) waves interspersed with two correctives (counter trend) ones. Once the 5 wave pattern of 3 Impulse + 2 Corrective waves is complete the whole structure stands to be corrected.Again this is a huge topic and we will discuss more of it later on. But the wave counts have been very popular and followed by many traders.
Wave counts - 1-2-3-4-5-A-B-C
ii. Harmonic Patterns Trading Strategies
These patterns are a special set of relations between consecutive price movements. It calculates retracements and extensions based on Fibonacci ratios. These patterns have funny names too, like bats, crabs, sharks, etc. But fun aside these are very potent if you know what you are doing.iii. Price Action Trading Strategies
This topic is a big topic in itself. There are as many interpretations of price action as there are traders. Again this method of analysis observes repeatable price action patterns and builds certain rules around them. When you follow these rules and develop a holistic understanding of the markets you can trade them very well.7. Trading Technical Indicators
The last topic here is the most common and popular among traders. Viz. trading indicators. All indicators are derived from price or volume. Applying complicated mathematical formulas to the price and volume data, traders have come up with thousands of indicators, the most common are RSI, Stochastics, MACD, etc.The problem with this methodology is that since the two basic inputs to these formulae are price and volume, they will always lag price and volume. In other words, they will always follow wherever the price will take them.
Logically it is impossible to predict where the price will go if you are using price as an input. But certain patterns in these indicators can indicate to the waning strength of buyers and sellers and also when they might be picking up the pace.
This information can be priceless if you have a deeper understanding of the markets principles. But without the sound understanding of how the markets work, relying solely on these indicators will not give you the desired results.
Conclusion
This how the trading strategies pan out. You can select the one that intrigues you the most and then study it in greater detail. Look out for future posts which will go into greater details into these strategies one by one, their pros and cons and potential solutions to these problems.
But right now you can tell me what you think about the posts in the comments section below. If you have any questions and doubts you can ask me in the comments. I promise I will get back to you with an answer.
And finally, do share this post with your friends and colleagues, help me spread the word., because...
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