Trading Strategy 

Trading in financial markets is an art and science. Many things need to be done carefully in both preparation and execution. One of the core elements of successful trading is a trading strategy. A systematic plan leading to trader decisions based on specific, predefined rules defines it. The article goes deeper into trading strategies, providing beginners a full comprehension of understanding, developing, and applying such strategies.  

What is a Trading Strategy? 

A trading strategy is an explicit plan to participate in purchasing and selling assets in financial markets. It mainly focuses on gaining profit along with managing risk in an uncompromising manner. Any good trading strategy would broadly be considered to comprise of the following: 

• Market Analysis: In-depth analysis of prevailing trends, conditions, and market patterns 

• Entry and exit criteria: The explicit rule conditions state the requirements for purchasing and selling a security. 

• Risk Management: Strategies that could limit possible losses while protecting capital. 

• Performance Analysis: Continuous examination that examines the strategy’s efficacy. 

Whatever investment, be it equities, currencies, or commodities, this strategy offers a set direction while making decisions, which ensures more rationality in opposition to emotions. 

Understanding Trading Strategy 

Trading strategies are typically segregated into two categories. 

1. Discretionary Trading

Discretion in trading is based upon intuitive ability, experience, and personal judgment of the trader. Traders relying on this type always make sense out of the market’s signals, news, or trends while deciding. Despite the flexibility, this type calls for a deep sense of the market and strong discipline at their command. 

2. Systematic Trading

Systematic trading involves executing trades based on predetermined rules, which can also be automated through algorithms. It saves traders from emotional biasing and allows them to process large amounts of data efficiently. 

There are two major analytical methods that traders use in the process of building a good trading strategy: 

Technical Analysis: 

Technicians rely on past price movements and developments to forecast future price trends. Moving averages, RSI (Relative Strength Index), candlestick patterns, and other technical indicators are some of the commonly used tools in this analysis. 

Fundamental Analysis: 

This approach looks at the underlying drivers that determine an asset’s value, which can be economic data, company financials, and industry trends. It helps determine whether an asset is overvalued or undervalued. 

A good trading strategy has: 

• Clear objective: It is defined with no ambiguity. 

• Consistent: Reliability in performing under similar market conditions. 

• Quantifiable: The outcome can be measured and analysed. 

• Verifiable: Its past performance can be used to backtest it to assess its performance 

Types of Trading Strategies 

The choice of trading strategy involves many factors, such as acceptable levels of risk, market situations, and available time. Here are some of the most usual trading strategies: 

1. Day Trading

Day traders open and close positions within one trading day and do not carry any risk overnight because this strategy involves small-scale price movements and requires total concentration and swift decision-making. 

Example: 

A trader tracks the share price of Tesla Inc. (TSLA) to detect short-term fluctuations and uses technical indicators like Bollinger Bands for this purpose. Here, buying is done upon hitting the lower band, and selling is done after reaching the upper band. 

2. Swing Trading

Swing traders establish positions for a few days or weeks to benefit from medium-term price movements. A swing trader relies on technical and fundamental analysis to pick trends and reversals. 

Example: 

A trader spots a bullish engulfing pattern in Microsoft Corp. (MSFT) and goes long on the shares, hoping the stock will rise over the subsequent week. 

3. Position Trading

This long-term approach keeps positions for weeks, months, or even years. Position traders pay more attention to macroeconomic trends and a company’s fundamentals and ignore short-term noise. 

Example: 

A trader invests in Amazon.com Inc. because he believes the company’s long-term prospects far outweigh short-term fluctuations in the market. 

4. Scalping

Scalpers make multiple trades in a day by aiming to profit from tiny price movements by making a few pennies. This requires high-end trading systems, very low transaction costs, and fast execution. 

Example: 

A trader scalps the SGX Nifty futures when price spreads narrow due to high liquidity periods, making rapid trades. 

5. Algorithmic Trading

Algorithmic trading, on the other hand, executes trades through computer programs according to predefined criteria. An algorithm can process large quantities of data and make trades in less than a millisecond, which is why it is popular in high-frequency trading. 

Example: 

An algorithm is programmed to buy Apple Inc. shares when the 50-day moving average crosses above the 200-day moving average, which signals a bullish trend. 

6. Trend Following

Trend followers enter trades toward established market trends for profit opportunities. They exit their trades once signals of a reversal show. 

Example: 

An individual follows an established uptrend in gold’s price and buys after the price retreats; to close the profits, a trader uses trailing stop-loss orders. 

7. Range Trading

Range traders identify the level at which the asset’s price oscillates constantly: the support level at which they buy and the resistance level at which they sell. 

Example: 

A trader finds a range for Netflix Inc. stock between US$300 and US$350. They buy when the price approaches US$300 and sell at US$350. 

Risk Management in Trading 

No trading strategy is complete without a good risk management plan. Trading intrinsically involves risk, and effective risk management is critical to protect capital and ensure long-term success. 

Critical Risk Management Practices: 

1. Position sizing:

Size each trade to a given percentage of the portfolio, taking as a common guideline the 1-2% rule-that is, risk only 1-2% of the portfolio on a given trade. 

2. Stop-Loss Orders:

The stop-loss order automatically closes a trade when the price reaches a predetermined level, thereby limiting possible losses. 

3. Diversification:

Investment should be spread across various assets or sectors so that poor performance in one area only affects a little. 

4. Risk-Reward Ratio:

The reward potential of a trade in comparison to the risk. In most instances, the ratio employed is 2:1. Therefore, the reward has to be at least double the probable loss. 

5. Regular Performance Reviews:

Perpetually review and adapt strategies given performance metrics and prevailing market conditions

Examples of Trading Strategies 

1. Example of Day Trading

A day trader is focused on Amazon.com Inc. (AMZN) stock, using the Relative Strength Index (RSI) to catch an oversold situation at US$100. He believes the price will bounce back, so he purchases some shares and puts a stop-loss order at US$98 to cap his potential loss. The stock now jumps up to US$105. He sells at US$105 and thus gains US$5 per share. 

2. Swing Trading Example:

A swing trader examines the candlestick chart for Alphabet Inc. (GOOGLE) and discovers the “double bottom,” which is frequently a signal of an upward reversal. He buys it at US$130, expecting the price to take off. When the share price reaches US$150, that is, to the resistance level, that is when it sells and makes US$20 per share 

3. Example of Algorithmic Trading:

Algorithmic trading automates the analysis and execution of the trades as per predefined rules. A good example would be considering a trading algorithm that monitors the currency pair, US$/SGX, and forex. It auto-buys when the price has exceeded the moving average for 20 days and auto-sells if the price goes down from the 50-day moving average. This ensures very prompt decisions and rules out any emotional trading, which leads the trader to benefit from good, consistent trends in currency. 

Frequently Asked Questions