Trading strategy
A trading strategy is a process for purchasing and selling stocks. A trading strategy is based on preset rules and criteria used to make trading decisions.
A trading strategy may be simple or sophisticated and involve investment style (e.g., value vs. growth), market cap, technical indicators, fundamental analysis, industry sector, portfolio diversification, time horizon, risk tolerance, leverage, tax considerations, etc.
A trading strategy must be carefully crafted using objective data and research. As market conditions or individual goals change, a trading strategy should be reevaluated and changed.
Key point
A trading strategy is basically a trading plan that includes many aspects and investor needs.
Planning, making trades, and executing trades are the three stages of a trading strategy.
At each level, strategy metrics are measured and adjusted based on market changes.
Most trading techniques use quantifiable data that can be backtested to verify accuracy.
Day-trading
Day trading is a popular active trading method. Active trading is a common alias. Day trading is buying and selling stocks in one day.
Day trading positions are closed the same day they are opened; none are retained overnight. Day trading is usually done by traders or market makers. Electronic trading has exposed this activity to beginner traders.
Pros
Profit from market volatility
Don't jeopardize capital by holding overnight on post- or pre-market pricing.
Fast-paced trading approach.
Cons
Higher order volume means more transaction fees.
Execution takes time and care
Smaller incremental earnings are more likely than huge wins.
Position trading
Some believe position trading to be a buy-and-hold strategy and not active trading. Position trading can be active trading for an advanced trader.
Position trading uses longer-term charts (daily to monthly) to assess market direction. Depending on the trend, this type of trade can take days to weeks.
To determine a security's trend, trend traders look for higher or lower highs. Trend traders ride the "wave" to profit from market ups and downs. Trend traders focus for market direction, not price levels.
When a trend breaks, trend traders frequently leave the position. High market volatility makes trend trading more difficult, therefore positions are minimized.
Pros
Less stressful than active trading
Simple, low-leverage tactics
Technical analysis tools provide trading signals.
Cons
Technical analysis experience required
Needs patience to spot long-term pricing changes
Small swings may cause losses.
Swing trading
Swing traders enter when a trend breaks. As a new trend emerges after a trend ends, price volatility is common. Swing traders purchase or sell when prices fluctuate.
Swing trades last more than a day but less than trend trades. Swing traders use technical or fundamental analysis to construct trading rules.
Trading rules or algorithms determine when to buy and sell a security. A swing-trading algorithm doesn't have to foresee the price peak or valley, but it does need a trending market. A sideways market is risky for swing traders.
Pros
Less time-consuming than day trading
Potentially greater trade returns
Trade while markets are closed
Cons
May lose money pursuing trends
Higher trade loss potential
Fewer, more centralized holdings
Scalping
Scalping is a fast strategy used by traders. Identifying and exploiting bid-ask spreads that are bigger or narrower than normal due to supply and demand imbalances.
A scalper doesn't try to profit from significant changes or volume. Instead, they focus on modest, frequent transactions.
Since scalpers make modest trades every trade, they seek liquid marketplaces to improve their trading frequency. Scalpers favor peaceful, non-volatile markets to swing traders.
Pros
Technical background isn't always required.
Trades less volatile assets, reducing market risk.
Profitable with slight pricing changes
Cons
Hefty order volume causes high transaction fees.
Due to tiny profit each trade, often requires considerable upfront cash to earn modest returns.
Time-consuming tactics
Conclusion
- A trading strategy is a plan for executing orders to generate a profit.
- A successful trading strategy should be objective, quantitative, and verifiable.
- The trading strategy should specify the assets to trade, risk tolerance, time horizon, and overall goals.