What Is A Trading Strategy?
Trading Strategy is a technique used by traders in the stock market to buy and sell shares during trading hours. Its main purpose is to determine the right strategy to book profits for the trader covering the potential risks.
Numerous trading strategies have been developed based on trading types. The appropriate method can protect traders from market volatility, provide diverse trading opportunities, and facilitate buying and selling within market sessions. However, determining the right strategy can be time-consuming and challenging for beginners.
Table of contents
- A trading strategy is a stock market approach where traders buy and sell shares during a trading session.
- It aims at plotting profits and minimizing risk.
- Significant trading strategies include long and short equity, swing, scalping, news trading, pair trade, trade signal, and social trading.
- A trader can easily develop a strategy that balances market volatility and momentum and depicts the trend using technical analysis and indicators.
Trading Strategy Explained
Trading strategy refers to traders’ approach to buying and selling stocks during trading sessions. It is a useful tool for booking profits and identifying future opportunities. Traders can develop long-term or intraday strategies using various technical indicators and fundamental analysis. Strategies can also be developed for options and futures trading.
Factors such as financial goals, risk levels, and trading products are important in forming a trading strategy. Applying the right strategy is crucial when investing in a particular stock, as using the wrong plan during high volatility can result in losses. Conversely, a well-executed trading strategy can yield significant profits.
Technical analysis and associated indicators such as RSI (Relative Strength Index) and MACD (Moving Average Convergence/Divergence) can aid in forming a trading strategy. However, the intraday trading strategy for options and stocks may differ depending on the trader’s investment activity. For example, long-term traders may employ different strategies than short-term or intraday traders. Therefore, selecting the appropriate plan and method is essential.
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Let’s take a closer look at some of the trading strategies used by traders during trading sessions:
- Long and Short Equity Strategy: This common trading technique involves taking a long position (buying) at low prices and selling at high prices to take advantage of market volatility. It is often used in trading hedge funds.
- Swing Trading Strategy: This strategy aims to profit from short-term trends and is based on identifying swing patterns formed with price volatility. It is typically used for long-term trading, lasting more than one day but less than a month.
- News Trading: This strategy involves trading in response to news and events about a particular stock, such as revenue results, annual reports, mergers, acquisitions, etc.
- Day Trading: This high-risk strategy involves buying and selling assets within a day of the stock market‘s opening hours (i.e., 9:30 am to 4 pm). Professional traders usually employ it due to the high volatility during this period.
- Pair Trading Technique: This neutral strategy involves identifying pairs of similar stocks and taking corresponding long and short positions.
- Scalping: Similar to day trading, this strategy involves trading multiple stocks daily and making profits from each deal.
- Trade Signal Strategy: Traders can use various indicators, such as momentum, trend, volume, and volatility, to decide when to buy or sell their stocks.
- Social Trading: This strategy involves using people’s behavioral patterns and habits to inform trading decisions.
How To Develop?
Let us look at the seven steps on how to develop trading strategies:
- Get Knowledge about the Market and Stock Market Trading: The first and foremost step to developing any strategy is to gain knowledge about the market and related components. Traders must read and acquire information about technical analysis and different stocks. In addition, learning about demand and supply forces eases most of the work.
- Choosing the Appropriate Market (Options, Equity, Forex, Futures): Once a trader has acquired enough data about the stock market, they can choose their trading instrument. For example, a person can develop a strategy in equities or derivatives.
- Deciding a Time Frame (Intraday or Long position): It is important in determining the strategic position. Here, traders can select from either being an intraday trader or conducting long-term trading. Again, the strategy also matters depending on the timeframe. For instance, a shorter period is suitable for a scalping strategy.
- Select the Right Technical Indicators: The indicators are crucial for determining the strategy. With the help of price tools, trend lines, and indicators, a trader can easily identify similar patterns in stock.
- Plan the Entry and Exit Points: Defining the entry and exit points becomes necessary before jotting down the strategy. And to determine them, market volatility and time frame play a vital role. Plotting entry points is possible when a trader uses candlesticks and bar patterns. However, a wrong exit point can trigger profits and invite losses.
- Define the Risk Levels: Now, traders must define their risk coverage potential. It measures how much risk they are willing to take on. So, if a person wants to double their profits, the risk equally jumps high.
- Preparing and Execution: The final step is to develop the final draft of the strategy, including listing the rules traders must follow during the execution. However, it is important to note that the strategy should remain flexible and subject to changes.
Let us look at some examples for a better understanding:
Suppose Vilsca is a 22-year-old graduate student doing a part-time hustle. She earns $200 per month to pay her education fees. And the rest of the amount turns into an investment. So, she invests a part of it in equities. To book gains, she buys a stock when it is performing low and sells it when it is running high. As a result, she equates the risk through a long and short equity strategy. However, it was only possible through trading strategy and indicators.
Nicholas Darvas, a ballroom dancer, in the 1950s created his theory and trading strategy to trade in the stock market. Before, he used to draw boxes, follow some rules and make $20,000,000 from $10,000. Later, his strategy became known as the “Darvas Box Theory.”
Trading Strategy vs Trading Plan
Although trading strategy and plan sound synonymous, they have a slight difference. Let us look at them:
|Trading Strategy||Trading Plan|
|A strategy developed for buying and selling securities in the market.||A detailed framework for executing trades in the stock market.|
|Focused on determining entry and exit points that will lead to profitable trades.||Focused on identifying the right securities to invest in and executing trades effectively.|
|Usually consistent across different securities.||It can vary depending on the specific security being traded.|
|Takes into account technical analysis, market trends, and other factors.||Takes into account personal risk tolerance, trading style, and financial goals.|
|It can be flexible and adjusted as needed.||Typically more rigid and structured, with specific rules and guidelines to follow.|
Frequently Asked Questions (FAQs)
Backtesting means testing a developed strategy using different tools. Various platforms like Microsoft Excel, Ninja Trader, and Trade Station are available to test it. Following are the steps for backtesting the trading strategies of the individuals:
– Clearly defining the strategy
– Deciding the financial market, timeframe, and position
– Backtesting the strategy with the help of a software or manually.
The 1% risk management strategy is a popular approach traders use to minimize their risk exposure in the market. Under this strategy, traders limit the capital they risk on each trade to no more than 1% of their total account balance. This helps protect their money from significant losses due to market volatility or unexpected events. Using this strategy, traders aim to achieve consistent returns over the long term while minimizing their risk of ruin.
Some popular options trading strategies include the long call and long put strategy, which involves buying either a call or put option, and the covered call strategy, where an investor sells call options on an underlying asset they already own. Another strategy is the iron condor, which involves selling both a call spread and a put spread on the same underlying asset.
This article has been a guide to what is Trading Strategy. We explain its examples, how to develop it, its types, and comparison with trading plan. You may also find some useful articles here –