Trading Strategies

Fundamental trading

Buy and hold strategy is very popular with stock investors. Because the US stock market was in a prolonged bullish condition for the last decades the concept relies on buying a stock selection, holding it for several years and taking the profits later on. There are different criterias that can be used to make a selection like Earnings per share (EPS) or dividend stocks. The main downside of this approach is the possibility of a prolonged bear market when the asset value could drop considerably. The belief is the companies produce real value over time reflected in the stock price.

High frequency trading

It’s done by machines at very high speeds (nanoseconds). It works by analyzing the order flow, trying to buy or sell based on predefined patterns. The few voices talking about this strategy tell stories that might not include necessary fair practices. Some consider it beneficial because it creates liquidity but others consider it detrimental because they ramp up the acquisition price. Just like in an arm race, the most technologically advanced player takes all, this being the reason many players get out of the game early.

Scalp trading

This strategy consists of small trades, done by humans usually on a time scale of 1, 5 or 10 minutes. They get in and out quickly, always trying to get a small but consistent profit. This is mostly based on intuition and mental patterns traders have developed over the years. Some strategies consist of order flow analysis. Traders use visual tools to determine quickly the liquidity situation, as a factor in the trading decision.

Day/Swing trading 

Traders operate on medium timeframes between 10 minutes and 1 hour. They rely on visual patterns or even on systematic backtested patterns. At this level the competition is still high and patterns might not work consistently. However there are a lot of successful traders that made a lifestyle out of this. One other element that might be specific to this strategy is the attachment to just a handful of known markets with specific behaviour.

Mean reversion

It relies on the premise that price over time reverses to an average level. The main problem appears on fast trends that push the price higher or lower from the mean for different periods of time. With good risk management this could be a profitable technique. If not done right the entire profit accumulated over a large period of time will be lost very quickly. Some call this strategy ‘picking up pennies in front of a steamroller’.

Trend following

The opposite of mean reversion. It’s believers consider the trends are something expected, based on human behaviour that happened with some frequency. The style presumes lots of small losses (whipsaws) but the few winning trades make up for it and then some. It’s usually done on large time frames like days or weeks and relies on an entry and exit signal computed based on previous backtests. The disadvantages of this method are large drawdowns that could mean even 50% of the stake size for long periods of time. The large numbers theory is used to explain why over time the winnings would cover the losses. Some call this ‘death by a thousand cuts’.

Pattern trading

It’s based on visual patterns like triangles, flags, wedges and double bottoms/tops. Based on the market conditions some traders associate a probability factor to each pattern. The main disadvantage of this style is the fact that each trader can see a different pattern based on its subjective interpretation. Some use patterns only on higher time frames as a guide and some rely heavily on pattern detection on all time frames and use it as a signal after the pattern is confirmed.

Artificial intelligence trading

Most of the traders don’t believe the algos are sufficient at this point. The main concern is the lack of data, because the last 40 years of available data is not enough to make a good prediction for the future. The risk of analyzing specific markets might make the bots overconfident and when the market makes a dramatic turn the algos will not be able to cope, generating large losses.

Option trading

It’s more like a niche than a trading style. Buying and selling options is a different strategy with a different reward/risk ratio. Traders usually lose the entire investment in case they are wrong but in case they are right the rewards are exponentially higher.

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