What Is a Trading Strategy?
A trading strategy is a systematic methodology used for buying and selling in the securities markets. A trading strategy is based on predefined rules and criteria used when making trading decisions.
A trading strategy may be simple or complex, and involve considerations such as investment style (e.g., value vs. growth), market cap, technical indicators, fundamental analysis, industry sector, level of portfolio diversification, time horizon or holding period, risk tolerance, leverage, tax considerations, and so on. The key is that a trading strategy be set using objective data and analysis and is adhered to diligently. At the same time, a trading strategy should be periodically re-evaluated and tweaked as market conditions or individual goals change.
Key Takeaways
- A trading strategy can be likened to a trading plan that takes into account various factors and requirements for an investor.
- A trading strategy typically consists of three stages: planning, placing trades, and executing trades.
- At each stage of the process, metrics relating to the strategy are measured and changed based on the change in markets.
- Most trading strategies are based on either technicals or fundamentals, using quantifiable information that can be backtested to determine accuracy.
Understanding Trading Strategies
A trading strategy includes a well-considered investing and trading plan that specifies investing objectives, risk tolerance, time horizon, and tax implications. Ideas and best practices need to be researched and adopted then adhered to. Planning for trading includes developing methods that include buying or selling stocks, bonds, ETFs, or other investments and may extend to more complex trades such as options or futures.
Placing trades means working with a broker or broker-dealer and identifying and managing trading costs including spreads, commissions, and fees. Once executed, trading positions are monitored and managed, including adjusting or closing them as needed. Risk and return are measured as well as portfolio impacts of trades and tax implications.
The longer-term tax results of trading are a major factor and may encompass capital gains or tax-loss harvesting strategies to offset gains with losses.
Developing a Trading Strategy
There are many types of trading strategies, but they are based largely on either technicals or fundamentals. The common thread is that both rely on quantifiable information that can be backtested for accuracy. Technical trading strategies rely ontechnicalindicators to generate trading signals. Technical traders believe all information about a given security is contained in its price and that it moves in trends. For example, a simple trading strategy may be amoving averagecrossover whereby a short-term moving average crosses above or below a long-term moving average.
Fundamental trading strategies takefundamentalfactors into account. For instance, an investor may have a set of screening criteria to generate a list of opportunities. These criteria are developed by analyzing factors such as revenue growth and profitability.
There is a third type of trading strategy that has gained prominence in recent times. A quantitative trading strategy is similar to technical trading in that it uses information relating to the stock to arrive at a purchase or sale decision. However, the matrix of factors that it takes into account to arrive at a purchase or sale decision is considerably larger compared to technical analysis. A quantitative trader uses several data points—regression analysis of trading ratios, technical data, price—to exploit inefficiencies in the market and conduct quick trades using technology.
Special Considerations
Trading strategies are employed to avoid behavioral finance biases and ensure consistent results. For example, traders following rules governing when to exit a trade would be less likely to succumb to thedisposition effect, which causes investors to hold on to stocks that have lost value and sell those that rise in value. Trading strategies can be stress-tested under varying market conditions to measure consistency.
Profitable trading strategies are difficult to develop, however, and there is a risk of becoming over-reliant on a strategy. For instance, a trader maycurve fita trading strategy to specific backtesting data, which may engender false confidence. The strategy may have worked well in theory based on past market data, but past performance does not guarantee future success in real-time market conditions, which may vary significantly from the test period.
FAQs
A trading strategy is a fixed plan for executing orders in the markets to achieve a profitable return. A good trading strategy should be consistent, objective, quantifiable, and verifiable. The trading strategy should outline the specific assets to trade, the investor's risk tolerance, time horizon, and overall goals.
What are the 4 types of trading strategies? ›
What is a trading style?
| Trading style | Timeframe | Common holding period |
|---|
| 1. Position trading | Long term | Months to years |
| 2. Swing trading | Short to medium term | Days to weeks |
| 3. Day trading | Short term | Intraday only |
| 4. Scalp trading | Very short term | Seconds to minutes |
A trading strategy is a fixed plan for executing orders in the markets to achieve a profitable return. A good trading strategy should be consistent, objective, quantifiable, and verifiable. The trading strategy should outline the specific assets to trade, the investor's risk tolerance, time horizon, and overall goals.
How do you structure a trading strategy? ›
A solid trading plan considers the trader's personal style and goals. Knowing when to exit a trade is just as important as knowing when to enter the position. Stop-loss prices and profit targets should be added to the trading plan to identify specific exit points for each trade.
What strategy do most traders use? ›
We've looked at some of the most popular top-level strategies, which include:
- Trend trading.
- Range trading.
- Breakout trading.
- Reversal trading.
- Gap trading.
- Pairs trading.
- Arbitrage.
- Momentum trading.
Moving averages are one of the most basic yet effective trading strategies. They calculate the average price of a security over a specified period of time and smooth out price fluctuations, making it easier to spot trends.
How can beginners start trading? ›
Here is a day trading guide for beginners
- Learn the basics of the stock market.
- Choose a broker.
- Set up a demo account.
- Develop a trading strategy.
- Start small.
- Be patient.
- Manage your risk.
- Take breaks.
Overview: Swing trading is an excellent starting point for beginners. It strikes a balance between the fast-paced day trading and long-term investing.
Which trading is most profitable? ›
The defining feature of day trading is that traders do not hold positions overnight; instead, they seek to profit from short-term price movements occurring during the trading session.It can be considered one of the most profitable trading methods available to investors.
How can I learn trading strategies? ›
The first step into creating your own trading strategy is to determine what type of trader you are, your time frame of trading, and what products you will trade. It is best to see how an asset performed in the past by looking at historical data and charts around the time frame to be traded.
A simple method which doesn't require any analysis or indicator: Open a trade in the direction of the daily candle any time during the day in your own time zone. Don't put a limit. Put a stoploss equal to the length of the candle.
What are the golden rules of trading? ›
Let profits run and cut losses short Stop losses should never be moved away from the market. Be disciplined with yourself, when your stop loss level is touched, get out. If a trade is proving profitable, don't be afraid to track the market.
How do I create my own trading strategy? ›
With these 10 simple steps, you can launch your trading career with a good foundation.
- Step 1: Form Your Market Ideology.
- Step 2: Choose a Market For Your Trading Strategy.
- Step 3: Choose A Trading Time Frame.
- Step 4: Choose A Tool To Determine The Trend (Or Lack Of)
- Step 5: Define Your Entry Trigger.
Developing a Trading Strategy
Technical traders believe all information about a given security is contained in its price and that it moves in trends. 2 For example, a simple trading strategy may be a moving average crossover whereby a short-term moving average crosses above or below a long-term moving average.
What is the difference between a trading plan and a trading strategy? ›
For example, 'Buy gold when it drops below $1250, sell when it reaches $1350' would be a very simple trading strategy. A trading plan is a comprehensive blueprint covering everything from your goals, motivation and attitude to risk, through to risk management rules and analysis of past trades.
Can I create my own trading algorithm? ›
If you choose to create an algorithm be aware of how time, financial and market constraints may affect your strategy, and plan accordingly. Turn a current strategy into a rule-based one, which can be more easily programed, or select a quantitative method that has already been tested and researched.
Can I automate my trading strategy? ›
Can you automate your trading? Yes, you can automate your trading! In fact, according to BusinessWire, algorithmic trading is responsible for 60-73% of all U.S. equity trading. Most brokers support automated trading and even provide easy to learn programming languages to build your first automated trading system.
How do I find a trading strategy that works for me? ›
Finding your trading strategy takes time, a lot of time. It is wise to open a demo account with a broker (regulated by the AMF or the FCA) and practice at length to first identify the elements you want to integrate into your trading strategy, then test it for several weeks to see if it allows you to earn money.
How to generate trade ideas? ›
Creating a Process for Generating Trade Ideas
- (If fundamental idea) use technical analysis to see if the idea's timing is right.
- (If technical idea) use fundamental analysis to see why the stock is going up.
- (If technical ideas) sift through the charts of your idea list and start eliminating the obvious misfits.
