Top 5 trading strategies
Choosing a trading strategy is one of the most important decisions that a trader will make. Learn about five of the most popular trading strategies and the difference between each of them.
Choosing a trading strategy is one of the most important decisions that a trader will make. There are many different types of trading, with the main differences between each of them being the time frame in which they are used, and the profit margins sought. Some seek large profits from long-term positions, and others are happy with small profits from short-term positions.
However, there are some commonalities between each of the different trading strategies. For example, each gives you the option of going both long or short, which enables you to profit from both rising and falling markets.
With that being said, let’s take a look at five of the top trading strategies:
Day trading is a trading strategy in which a trader will open and close all their positions before the markets close for the evening. In doing so, they avoid some of the risks and added costs associated with holding a position overnight.
A day trader may carry out a large number of low value trades in a day. They must therefore pay close attention to market news and carry out regular analysis if they are to be successful. They will try to generate quick profits from small price movements. That means that this type of trading is best suited to full-time traders, who have the time to pay constant attention to the markets.
Due to the short timeframe, day traders do not have the luxury of riding out short-term moves against their positions. This means that they need to cut their losses quickly to ensure that any loss does not eat too much into their profits. To mitigate the risk of losses, day traders often use stops and limits to keep any potential losses at predetermined ‘acceptable’ levels.
As opposed to day trading, position trading involves holding onto an asset or maintaining a position for a long period of time. Often, this can be anywhere from weeks, months or even years. Position trading differs from the other trading strategies listed here as it is not a day or short-term strategy.
As such, position traders are unconcerned with market fluctuations, and will generally ignore short-term slumps in the hope of capitalising once the market recovers.
Position traders will make far fewer trades than day traders, but their trades will tend to be of higher value and are held for a longer period of time. While this increases the potential for profit, it also increases the trader’s exposure to risk.
There are a number of trading strategies within position trading, including the range, pullback and breakout trading strategies. Typically, position traders will rely on fundamental and technical analysis, often using tools such as a Fibonacci retracement which allows them to identify periods of support and resistance.
A swing trader will use a mixture of technical and fundamental analysis to spot ‘swings’ in an asset’s price movements. A ‘swing high’ is when the price of an asset swings upwards, and a ‘swing low’ is when it moves downward. As opposed to the two previously mentioned trading strategies, swing trading does not have a fixed time scale but is generally used by traders in a two-day to weekly window.
The overarching goal of swing trading is to spot a trend and then capitalise on the swing lows as periods of buying, and the swing highs as periods of selling. Swing traders often search for markets with a high degree of volatility as these are the markets in which swings are most likely to occur.
Moreover, swing traders tend to focus on ‘intrinsic value’ rather than the current market value when looking for assets to trade. Intrinsic value denotes the estimated ‘true value’ of an asset, which is not necessarily the same as the current market price. As an example, let’s look at the intrinsic value of a publicly-listed company.
Swing traders would look for periods when the current market value of the company’s stock is below or above the perceived intrinsic value of a company’s stock. They would then place a trade in the hope that the market price will correct to reflect its intrinsic value.
Similar to other trading strategies, trend trading is dependent on the prevalence of a particular trend, and can therefore be a short, medium or long-term strategy. As a result, traders need to be able to recognise when to open and close their positions in order to maximise profits.
Typically, trend traders rely on a trading plan with strict entry and exit requirements, as well as a large degree of technical and fundamental analysis in order to spot current market trends.
Trends can work in either an upward or downward direction. For instance, you could have a strong downward trend, which would indicate that sellers are dominating in a market. Equally, you could have a strong upward trend which would suggest that there are more buyers than sellers, forcing the price up.
Scalping is a form of day trading and involves opening and holding a position for a very short amount of time – generally a few minutes but sometimes just a few seconds. Traders who use a scalping strategy are known as scalpers.
Unlike swing traders, scalpers tend to avoid markets that are moving spontaneously and in an unpredictable trend. They require market volatility, but only so long as that volatility moves the market in a way that is consistent with its previous patterns. Adding to this, since the amount of profit per trade is often quite small, scalpers normally look to trade in high-liquidity markets.
To be successful, scalpers need to be strict in the parameters they set to exit trades. This is because any losses can quickly wipe out profits and they need to close unsuccessful trades quickly instead of riding out slumps. For this reason, many scalpers use automated trading systems to benefit from their increased order execution speed.
The benefits of scalping are that since a trader will only hold a position for a very small amount of time, their exposure to risk is reduced considerably. Adding to this, smaller moves in the stock markets are more common than larger moves, which means that scalpers have a considerable opportunity to realise a profit.
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