Stock trading strategies vary wildly from multi-decade long term investors to minute to minute intra-day traders. You will read about some strategies here that have very clear cut boundaries, know that most traders do not follow these rigorously.
You will see many prominent traders mixing and matching strategies to fit their own needs and styles. Its very easy to consider yourself a swing trader with a tendency to jump on shorter trades when you see the opportunity. Blend day trading with break-outs, swing trading with some long term stocks for investments.
Its all about your current needs and the goals (you should have some goals if your going to trade) that you have set for yourself.
1. Value Traders
The concept of value is an attractive one regardless of how it’s being applied. A person shopping for a car may pick up a pre-owned vehicle with low mileage because it’s a good value purchase over a new vehicle. The fantasy football player may look at the rookie third-string wide receiver selected in the 9th round of their draft as a value pick because of the player’s upside.
Value – specifically, value trading – is a prime concept that can be utilized in the stock market. The idea of finding value on the market goes back to 1928, when its principles were fleshed out by the Columbia Business School. The notion is built around the principle of picking up a stock at a discount in relation to their intrinsic value. In other words, the principle is based on finding stocks that are worth more than what the current market would have you believe.
Defining the Intrinsic Value
In order to grasp on value trading works, you must first understand how intrinsic value operates. Generally speaking, this term works in conjunction with the concept of value trading when the stock is trading lower than what the value of the company is as determined by projecting future cash flows. Ideally, this gap between the two camps – initially defined as a “margin of safety” – falls between 30% and 40%.
Companies that create large margins of safety are usually ones in decline. However, there downward pattern is represented on the market as an overreaction, which ends up pushing the stock price much lower than it should. As time progresses and future cash flows convert to the present tense, the market will correct itself, therefore causing a significant spike in price.
This is what the value trader is looking for. Ideally, they will buy the stock when there is a sizeable gap between the current stock value and its intrinsic value, and ride things out until this gap closes.
Value Trading – Not for the Faint of Heart
If the notion of trying to find undervalued companies on the stock market sounds difficult, it’s because it is. The goal behind value trading is cash in on cheap stocks, and doing this successfully requires a considerable amount of work. You need to do substantial scrutiny of a targeted company in order to ensure it’s a good fit for this kind of trading. This assessment is built on principles like determining dividends cash flow, book value and earnings growth. These metrics carry more weight than the actual stock price, because they provide the data you need to predict the company’s intrinsic value.
When deploying this strategy is successful, the results can pay off handsomely once the market corrects itself. However, some investors may deem this to simply not be worth the effort, considering the labor-intensive nature required.
The Tools of the Value Trade
As is the case with any type of investor, value traders should settle on a strategic formula that suits their comfort zone. With that being said a sound investment strategy will typically contain the following guidelines that helps govern the process:
- A Price Earnings Ratio (P/E) that’s in the bottom 10% of its sector.
- A Debt to Equity Ratio of less than one.
- A PEG (that is, a P/E growth of earnings) of less than one. This may be a prime indicator that the stock is undervalued.
- A Price to Book ratio of or less.
- Strong earnings growth over an extended period. Realistically, you’ll be looking at a number in the 6 to 8 % ranges over the course of 7 to 10 years.
- Not paying more than 60 to 70% of the stock’s intrinsic per share price. This will give you that coveted 30 to 40% “margin of safety”.
As far as actually finding the undervalued stocks, the value trader will deploy a three step process. Firstly, they’ll sort stocks formulaically in such a way that the lowest P/E stocks become easily identifiable. Once this occurs, the value trader will deploy various schematics to determine if the stock is truly undervalued or if it’s just bad news. Finally, they will make a determination as to if the stock price is going to land in that margin of safety in relation to the stock’s intrinsic value.
If a stock does fall in the “margin of safety,” the final trick to a successful value trader is to play the waiting game once the funds are invested. In a sense, this aspect of value trading is not unlike what you’d see in a buy and hold investment situation. Value traders should never go into purchasing an undervalued stock thinking the gap is going be closed overnight. Slow and steady wins the race here.
Technology – the X Factor behind Value Trading
Value trading can be a finicky beast, and this is laid out pretty plainly when value traders attempt to strike gold with tech stocks. The constant advancement of technology can cause tech stocks to become undervalued in a hurry, as one company that moves tech forward inevitably will push other companies back. However, mining these types of companies can be a tough row to hoe, because finding success within these companies from a value trading standpoint is dependent on whether or not the company that has fallen behind in the tech race takes measures to catch up and stay relevant. As once-mighty companies like Blackberry have demonstrated in the last decade, today’s news can become tomorrow’s fish and chip paper in the tech industry. If value traders aren’t careful with these particular companies, a sure thing can turn into a big loss rather fast.
Caution + Patience = Payoff
For the savvy investor that thrives on the thrill of getting into market minutiae, the concept of value trading can be rather attractive. It’s not an easy task, and it won’t produce immediate dividends, but those drawn to value trading aren’t looking for simplicity or fast money. They’re essentially looking for a stock market equivalent of the rookie third-string wide receiver in the middle rounds of their fantasy football draft. More often than not, the right type of those picks ends up with the picker experiencing glory in the long run.
2. Trend Traders
“Let it ride” is a term people like to use in Vegas when they’re having success with a hot table. After all, if the dice or cards are good, why not keep the benefits of that momentum going as long as it lasts? In a way, the world of investing has its own form of “letting it ride”; a concept called trend trading. This long-term yet reactive approach to trading is designed to latch onto an upward trending stock and ride its momentum until the trend changes course. It may not have the luster of the craps table, but to trend trader, this hardly matters.
The Straight, Narrow Path of Trend Trading
Trend trading is unique in the sense that it eschews the parameters of prediction and “gut feeling” that is commonplace in a lot of investment strategies. The backbone of the practice is built around a risk management system that chiefly wages on three factors:
- The current price of the market
- The level of equity in the trader’s account
- The current volatility of the present market
There is no seer-seeing involved, nor is there any room for taking an emotionally-charged guess on how the chips are going to fall. Rather, it is a highly disciplined system built around a systematic rule that determines when their personal buy rate and/or the sell rate will be. If the market moves slightly off this number one way or another, they hang with that investment. If it deviates too far off, it could lead to the whole trade being jettisoned. It’s a strategy that tends to work – historically speaking, a trend trader’s average profit tends to be much higher than the average loss.
The Essence of Emotion Control
Successful trend traders will approach the stock market in a manner reminiscent of Mr. Spock from Star Trek; void of emotion, logically following the progression or regression of the market based wholly on the self-set parameters. The strongest adherents to this method are known as systematic trend traders, and they’re pinpointed as being people that follow non-emotionally-charged trading rules usually based on mathematical market behavior tropes. They aren’t interested in what their conscience may be whispering in their ear about what to buy or sell; they are driven solely by the opportunity to capture the majority of a market trend to achieve the largest amount of profitability possible. What’s more, they seek these profits over multiple asset classes, be it stocks, options, bonds, commodities, or currencies.
Success is found in these various avenues by exclusively following and taking advantage of established trends. They don’t occasionally dabble in up-and-coming stocks or things with great potential. Even though these things elements may be tempting and even fun to pursue, doing so interferes with their ultimate pursuit of market momentum.
The Method to a Trend Trader’s Madness
As one may guess, the method typically deployed by a trend trader is uncomplicated. It’s essentially made of two components. The first component involves identifying the trendy stock. This component starts out simplistic enough, but it gets a bit complicated once the trader determines the time frame in which the trend needs to be viewed. This is a period is viewed on a weekly, monthly, or a yearly basis as to get a bead on just how profitable the stock can be over time.
The second part of the strategy is to determine the trade breakouts. The use of a solid price breakout strategy is important in helping the traders’ deuce new highs and lows on intervals as broad as a monthly level or down to the minute. This strategy also helps them to figure out how likely a stock’s momentum is going to continue.
The Advantages of Trend Trading
The presence of non-emotional, cold logic to determine a stock’s profitability is appealing because it cuts out a lot of the rhetoric present with other trading strategy. As long as the trend trader has access to daily market data, they have all they need for success.
The reason they can eschew the peripheral stuff is that they threaten to pump the investor with ideals of hope and speculation, which are big no-nos in the trend trading game. Besides, since a lot of this stuff doesn’t necessarily concern established market trends, it tends to not concern trend traders in the first place.
If trend traders are disciplined enough, they can profit in the marketplace in bear markets as well as bull markets. The reason for this traces back to discipline and a dedicated ignorance of self-emotion. In other words, good trend traders won’t panic if the market bears its claws; they’ll steady the course instead. This discipline tends to serve them well when others around them start to panic when the market turns volatile.
Perhaps most importantly, trend traders take a scientific approach to the stock market; one that is ultimately defined by the journey, not the result. While successful trend traders will note that the endgame will result in monetary happiness, such a finale may not be possible by diverting focus on how to get to the endgame.
The Perils of Trend Traders
Even the most logic-driven trend trader may hit a few pitfalls from time to time. The biggest one is known as a false start, or a whipsaw. This happens when the setup produces a positive signal, but is immediately followed by a reversal. This knocks trend traders out of their position when the set produces another positive. The second pitfall is what is known as a shakeout. This occurs when dramatic market changes caused by uncertainty or erstwhile bad news forces traders’ hands, and they have to end up selling their position. More often than not, these sales occur at a loss. Of course, there is always the potential for human emotion to creep into the process, in the form of jumping the gun and taking profits too early or stubbornly holding onto a stock too long before exiting.
Keep Those Emotions in Check!
Of course, stuff like late exits and early profit taking are minimized as long as the trend trader’s emotions are equally held in check. As such, if an investor is game for building a time frame around a trade and sticking to that framework regardless of what the market or their gut does, trend trading may be a terrific option to consider.
3. Swing Traders
There tends to be a certain rhythm to the stocks from a long-term perspective. Sometimes, stocks may trend upward for a consistent period of time. Other times, stocks may consistently slide down. Recognizing, analyzing, and advantageously using these trends is the bread and butter of a swing trader; a hardcore trader that enjoys digging deep into the long-term waxing and waning of specific stocks.
"Swing trading has been described as a kind of fundamental trading in which positions are held for longer than a single day. This is because most fundamentalists are actually swing traders since changes in corporate fundamentals generally require several days or even a week to cause sufficient price movement that renders a reasonable profit" -investopedia.com
The Difference Between a Swing Trader and a Day Trader
In some respects, a swing trader represents the polar opposite of a day trader. Where a day trader may concern themselves with intently following some stocks for a few hours to try to quickly capitalize on a short-term flourish, a swing trader’s analytical scope is broadened out to a significantly longer time frame. This scope of analysis could last several weeks, if not several months, before action is taken.
The reason for the extended analysis has everything to do with gauging the momentum of the stock market when pulling the trigger on specific stops. As their name implies, these traders will follow the general swings of the market as a whole, using these long-term ebbs and flows to dictate when to buy or sell stocks depending on the market’s direction.
While the swing trader’s method of operation is generally congruent with the market’s gains and losses, there necessarily isn’t any concrete playbook that all swing traders draw from to define various trends. Each swing trader has their own criteria that helps them define what actions to execute, and when those actions should be executed.
This method of operation represents the fundamental difference between a swing trader and a day trader. Because the day trader’s method is so hyper-focused on the here and now, it may practically morph into a full-time job fueled by the constant need to keep on top of up-to-the-second stock and market trends. Because swing traders are invested in stocks for a longer time, they can keep tabs on various market trends and such at their own leisure, such as the lunch hour or on the subway during their morning commute.
The Philosophy of a Swing Trader
The core mindset of swing traders is one that is built on keeping a close, careful watch on technical and fundamental analysis. Typically, this mentality will drive them to hone their focus on a specific industry, so they can become experts. This narrowed focus enables them to dive deeply into metrics like industry forecasts or company financial reports to make decisions based on the most intimate knowledge possible.
The best way to look at how swing traders view the market is to think of their philosophy as one that is cyclical. This cycle is broken up into four stages.
1. Basing – This is the stage where stocks are consolidated as buyers and sellers achieve symmetry. Think of this as “ground zero” for swing traders, used to determine when a stock should be bought and sold.
2. Advancing: This stage is defined by the stocks’ upward mobility.
3. The Top Area: This stage marks the time when the upward-trending stock’s momentum starts to stall before it peters out. If you’re looking at a chart, you’d likely see a double top or a head and shoulders pattern manifest at this stage.
4. Declining: This stage is where the pinpointed stock downtrends, an act caused by sellers jettisoning their stock, which in turn causes a lower stock price.
This particular cycle repeats itself over and over again. There is no set time frame for the cycle to play itself out, either. It is wholly up to swing traders to use their analytical shrewdness to make this rhythmic pattern more predictable.
Ideally, swing traders use data to hone in on a visible chart symbol such as a candlestick pattern to let them know if a stock is landing into what’s known as a “mini uptrend.” This surge, which happens in the Advancing stage, serves as a prime indicator the stock is geared toward profitability. This is the point where swing traders pull the trigger and buy the stock. If it continues to be upwardly mobile, they have a winning stock on their hand. The only caveat to this is that they need to make sure they sell while the stock is in the Top Area stage, since the stock’s profitability may tank once it reaches the declining stage.
The Advantages of Swing Trading
There are several pluses to the art of swing trading – and it is an art form. Possibly the biggest advantage to the practice is that the potential returns tend to be higher than a traditional “buy and hold” investor may see. These higher returns make it possible for smart investors to make a living off swing trading. That’s why swing trading an art form. Because of the ebb and flow of the market, swing traders can and will experience lean times. Smart swing traders will plan for these ruts by setting aside funds when the going is really good.
With that being said, swing traders tend to experience less risk than their long-term playing counterparts. The reason for this is because it’s much easier for them to jump out of losing trades than the long-termers, who must slog through any instance of a bear market syndrome. Also, while it’s a good idea for swing traders to keep tabs on the market and financial statements, it’s not as critical to do so as it is with other investment types.
Additionally, swing traders aren’t married to their computers when the market’s open. Unlike day traders who have to watch the market intently, swing traders can set their targets and stop loss orders and go about their business. This certainly has an appeal for those that don’t want to hover over their laptop all day. They also don’t have to worry about waking up and discovering their profits evaporated overnight.
In short, swing trading provides investors with the maximum amount of return with the minimal amount of work out of any training style. If you have a basic read of how the market trends – that is, let investments mature when trends point upward and let them be short during downturns – you may have a pretty decent chance of seeing success.
4. Pairs Trading
The stock market is an entity that is driven by pairs. One trader buys, one trader sells. A stock goes up, a stock goes down. It’s a synergy that’s quite beautiful to watch, unless you’re losing your shirt because your portfolio took a nosedive. Pairs trading tries to capture that sense of synergy by isolating this coupling to the sole investor.
The Long and Short of Pairs Trading
Pairs trading is a relatively new trading concept. Generally speaking, it’s origin is credited to a cadre of mathematicians, physicists, and computer scientists brought together by Morgan Stanley & Co. in the early to mid-1980s. At first glance, it looks like something that an analytical collective would have crafted, because there seems to be a near-scientific rhythm to how pairs trading works.
"If pair trading can drive a billionaire to suicide, I think that tells you that you should stay away as well. My recommendation: Keep your life simple — don't do pair trading." - Lex Van Dam from Why I won’t teach pair trading to my students
Pairs trading is what is known as a market-neural trading strategy. It works by finding a correlation between a long position and a short position in a pair of highly linked entities such as two stocks, currencies, options, commodities, or exchange-traded funds (ETFs). Once these have been determined, pairs traders will follow the two stocks closely, waiting for a moment where the correlation exhibits a sign of weakness. When this happens, the pairs trader will go “long” on the underperforming stock and go “short” on the overperforming stock, eventually moving to close the position once the correlation between the two returns back to normal.
The profit that is derived from this strategy is culled from the difference in price change that develops between the two instruments, as opposed to the direction that each instrument moves. The profit can be broken down thusly: If the long position goes up more than the short, or the short position goes down more than the long, the pairs trader will have made some money on their investment. In an ideal situation, the long position will increase and the short position will fall, which will create a maximum profit. However, this is not wholly indicative of a successful pairs trade. Because of the nature of pairs trading, it is conceivable for a pairs trader to earn a profit even during times where the market is trending downward or sideway, or when the market is suffering from low vitality.
The Science and Technology Behind Pairs Training
The reason why Morgan Stanley & Co. brought on a bunch of analytical types to essentially create a new way of stock trading was to create an advanced statistical model that could be used to develop and automated trading program, which could be used to take advantage of market imbalances. This process was more or less born out of studying arbitrage opportunities in the equities market. This study produced the development of quantitative methods that were used to identifying pairs of securities that were highly correlated. This method turned out to be highly profitable – Morgan Stanley was said to have made about $50 million in profits. However, the trend fell out of favor rather quickly, as two successive years of poor results put the kibosh to the project.
Yet a funny thing happened to pairs trading on its way to irrelevance. The dual-headed beast of advanced trade technology and the internet have brought this form of trading to the masses. It’s not as popular as some of your typical or traditional trade-based mechanics. However, it has gained modest interest amongst those who shape their investment strategies around market-neutral principles, such hedge fund traders.
The advent of 21st century technology and online trading tropes has created a pretty level playing field for individual investors whose idea of being in on the action may or may not involve sitting in front of their computer in California in their pajamas at 6:30 AM. These unique traders now have tools like real-time market data at their fingertips, often at very affordable rates.
Granted, the gap between the individual investor and the big boys of Wall Street has not closed despite the advent of techniques like pairs trading. It’s probably safe to say this gap never will be fully breached. After all, individuals won’t have things like economies of scale or robust proprietary systems at their disposal. With that being said, those that are into analytics – not unlike the people that were hired by Morgan Stanley all those years ago to develop pairs training – may be able to use the access to the key analytical tools like real-time financial market data, advanced computer modeling, and direct access trading platforms to their advantage. The fact that some of these complex trading strategies can be automated doesn’t exactly hurt, either.
Advantages and Risks of Pairs Trading
Because there are links between pairs trading and hedge trading, it’s easy to surmise that one of the biggest advantages behind pairs trading is how it controls risk. Since the two stocks purchased correlate, any loss that is experienced by both stocks biting the bullet will be minimized.
There is also no worry about directional risk cropping up within the trade. This is because the profits on a pairs trade depend on the difference in price change between the two instruments. Again, this relates to the hedge-like nature of the trading strategy.
The primary drawback to implementing this strategy – particularly for individual pairs traders – is that it demands twice the cost for commissions and fees. This makes perfect sense, of course. After all, the pairs trader does need to invest in double the amount of stocks in order to make the strategy work. If an individual plans on being aggressive or active with this strategy these costs can add up quickly to the point where making a profit may not be possible.
A Perfect Pair
Pairs trading may be viewed as a trading strategy ideally suited for the 21st century. By using analytics, hedge trading sensibilities, and technology that wouldn’t have been available prior to the internet age, individual traders can feel relatively comfortable with jumping into the market and implementing the strategy to cultivate profits in a relatively safe way. Not bad for a trading strategy developed by a bunch of analytic types.
5. Options Traders
In the investment world, a trader type is spelled out by their nickname. Options traders are a perfect example of this. As the name suggests, an option trader is someone that buys and sells options in the capital market. While the term is easily self-definitive, the actual mechanics behind the term is a little more complicated.
Options Trading vs. Stock Trading
The first thing that you need to know about options trading is that it is not stock trading. In stock trading, traders gain when a stock rises, and lose when a stock falls. Options trading, on the other hand, isn’t as cut-and-dried. These types of traders need to not only pick the right way the stock is going, but this predicted movement must happen within a specific time, or before what is known as the expiry date. What’s more, options traders must deal with what is known as implied volatility, or IV, which defines how much movement the stock is expected to have as speculated by call and put traders.
While this approach may sound a little harried to those that like a little breathing room associated with their investment strategy, options traders are a great strategy to deploy for people that don’t have a whole lot of capital to commit. What’s more, options traders can earn as much profit as they could through other training techniques, if not more. This, then, means that options traders can potentially provide the trader more “bang for their buck.”
The Rationale Behind Options Trading
Even if you’re not restricted from other trading options because of budget, options trading may still be a tremendous market strategy to deploy. Obviously, getting a nice chunk of change for a minimal investment is pretty attractive, but the allure behind options trading goes beyond this.
For one thing, options trading can shield the smart, successful trader from the type of market volatility that constantly threatens to give investors headaches. The simplicity of the practice and the limited time frame work together to minimize the issues that could stem from “flash-crash” markets, unexpected economic situations, and the kind of corporate-fueled news that could turn the long-term futures of a stock on a dime. This makes it possible for the options trader to make money in the market even in situations when the market is plunging.
Another appealing factor behind options trading is that the type of strategy that can be deployed is somewhat surprisingly diverse. Successful options traders can turn a profit on all market environments by trading a wide range of strategies on highly liquid exchange-traded funds on broad-market indexes. This amount of diversity makes the ability to potentially profit off of options trading virtually unlimited.
With that being said, successful options traders will know that the amount of profit culled can be stronger at certain times. These times are typically dictated by corporate-fueled events, such as quarterly earnings reports. Because some of these events happen throughout the year like clockwork, options traders can plot for these events methodically.
Furthermore, successful options traders can profit by picking up call options on upwardly trending stocks. The time frames that surround the call options end up acting as a sort of financially-fueled insulation for the investor, which in turn could produce a much lower dollar risk than purchasing the stock.
The Many Benefits of Options Trading
As one may guess, the numerous mechanics behind options trading provide several benefits that manage to move beyond the realm of “big money for a little investment.” While these benefits do tie back to efficient profitability, they also demonstrate the many ways that profitability within this trading strategy can be reached.
For instance, options trading provide the investor with a tremendous amount of leverage. Because of the diverse nature of the strategy, an investor is not stuck to just one methodology to earn profits. This freedom makes it possible for one to hedge their investments easily, therefore providing further insulation to their overall portfolio. Options trading also give investors the freedom to use this leverage to predict the direction of a stock, making it possible for them to gain money on stocks even when the stocks aren’t profitable.
Options traders can also typically find ways to save money on certain market-related necessities such as commission payouts. The online brokerage game is saturated with plenty of competition when it comes to options trading, which typically translates to companies offering discounts that aren’t necessarily seen with other types of trading, such as trading for stock. This, then, puffs up the investor’s potential for profit margin even more.
Because the risk of loss tends to be mitigated with options trading, traders may feel empowered to explore a much wider range of instruments in order to turn a profit. It’s possible for options traders to build up a wide-ranging portfolio filled with foreign currencies, index products, agricultural products, interest rates, and much more. This broad scope not only works to provide leverage to the portfolio, it may even add a little bit of fun to the proceedings.
Finally, there is very little hassle involved in making the transactions. Successful online traders can make their moves much more efficiently than if they were trading shares, where the money can be tied up for a much longer period of time. This efficiency allows options traders the chance to move their money into other avenues of potential profit quickly, which translates into far fewer instances of “what might have been.”
An Attractive Option for a Reason
Even though options trading don’t guarantee profitability – no trading strategy can make that claim – this strategy is nonetheless quite alluring because it allows smart investors to procure big profits on smaller, diverse funds, all with a minimal amount of risk. It’s the kind of scenario that people that are just getting into the market on a serious level may find especially attractive, because these parameters tend to match to the kind of framework that shows up in their dreams. After all, who wouldn’t want to jump in on something that has the potential to be a low-cost, low-risk, and high-reward venture?
6. News Traders
The news keeps us aware, informed, and in touch with the world around us. For the stock trader, it can also be the biggest influencer of trading strategy out there. After all, a little rumor or a change in executive power could have dramatic shifts – and tremendous dividends – within the stock market. The traders known as news traders know this, and have synthesized this knowledge into the backbone of its trading strategy.
What is “Trading the News?”
When discussing the philosophies of news traders, the term “trading the news” may pop up frequently. As one may guess, the term is reference to a technique used by traders to predict market movement based on extrapolated news data. We’re not talking about the evening news here, either. Rather, trading the news involves exchanging things like economic reports, announcements relating to quarterly performance, or whispers of huge business transactions churned straight from the rumor mill. All of this information can relate to key data that can have big fluctuations on a company’s share price. News traders use this information to better position themselves to take advantage of these situations should they manifest.
Trading the News in the 21st Century
It can be argued that no other form of trading has undergone a bigger paradigm shift than news trading. The reason for this is simple: the way news is received has dramatically changed.
Back in the day, a lot of the news used by news traders came from a place of objectivity; one in which the information behind the news trades was put forth in a neutral manner that covered all side of the equation. There was no room for personal, off-the-cuff analysis or personal opinion. Everything was relevant in regards to the warranting of press overage.
Fast forward to current times, when all anyone needs to be considered a “journalist” is a laptop and a blog. This new form of technology and associative reporting has undoubtedly increased the speed of information getting to our ears, which is a good thing. The downside to this is that some of the info may be more subjective than objective, with little or even no evidence to back up any claims.
This has fundamentally changed how news traders need to go about their business. It’s imperative that they consider new angles to the practice that weren’t even thought of so much as a decade ago. First, finally, and all things in between, every source of news must be looked at with great scrutiny to make sure objectivity is being held up. A juicy bit of speculation may not have a whole lot of luster to it if it is delivered in the form of a Tweet. Even old, reliable sources like newspapers or commercial organizations are to be viewed with suspicion, as the masquerade of PR-blurb-as-new-article has become prominent enough to blur lines.
For news traders that don’t recognize this trend, or even think that it’s going to fall by the wayside, they may be setting themselves up for a world of hurt. While trading the news has always required a sizeable amount of scrutiny, this special form of analysis must be dramatically increased if the hopes of a profit are to be realized.
The Methodology of News Traders
Legitimate news from legitimate news sources travels very fast. With the proliferation of online technology, it moves even faster. As such, news traders need to have a reactionary spirit; one that develops an innate talent to parse the news and its source, determine its impact on the market both from a short-term and a long-term viewpoint, and act upon those metrics.
Because important, decipherable news can come from any source at any time, it’s important that news traders develop a knack for efficiently deciphering news. Depending on the market, vital stuff like economic reports, corporate shakeups, or quarterly earnings records can cause rapid volatility. If a news trader isn’t prepared to hop onboard at the onset of the announcement, it may be too late for them to come along for the ride by the time a determination is made.
Obviously, this means that news traders have to constantly be in tune with the wheelings and dealings of the day as reported by various news outlets. Successfully trading the news demands a lot of time and a lot of focus, if only because hot financial or economic news can turn cold so rapidly. Taking a causal approach to this kind of trading seems a sure way to spell disaster.
The underlying motif behind news trading isn’t just rooted in interpreting the news. It’s knowing what to do with the information once the code has been cracked. The pursuit of profitability for a news trader is built on prediction, and they must be able to swiftly determine whether or not a news item is influential enough for them to buy a stock and ride what they think will be an uptrend. Of course, this works both ways. A news trader may want to quickly jettison a profitable company stock if bad business news pertaining to the company starts to swirl.
News traders will ultimately take these metrics to create a situation where they can gain profits on short-term reactions to market news. Oftentimes, a news trader will get intimately familiar with a particular industry or market, which can theoretically make it easier for them to separate genuine news from opinionated-driven hype.
The Thrill of Breaking News
News trading offers a unique sense of excitement that isn’t found in other forms of trading. There is a certain buzz that is organically created once market-shaking news breaks; the successful news trader will be in prime position to be among the first people in the market to catch the buzz. When you compound this feeling with the inherent rush that comes with being involved in the action of the stock market, it becomes easy to see why people may be drawn to this type of trading. While the way we receive news may have changed in this century, the excitement behind the news is as strong as ever.
7. Momentum Traders
If you pay attention to the high volume, high percentage moving stocks that tend to grab a chunk of headlines after Wall Street’s closing bell, you can rest assured that momentum traders had a hand in some of those transactions. News-worthy heavyweight stocks that trend upward on high volume are a momentum trader’s bread and butter, and their tendency to pick them up and sell them off as quickly and as profitably as they can makes them one of the most unique traders in the stock world.
Momentum trading carries with it a higher degree of volatility than most other strategies. Momentum trading attempts to capitalize on market volatility. If buys and sells are not timed correctly, they may result in significant losses. Most momentum traders use stop loss or some other risk management technique to minimize losses in a losing trade. -Fidelity.com
Is Momentum Trading the Same as Trend Trading?
On the surface, there appear to be a whole bunch of similarities between momentum trading and trend trading. Both traditionally eschew peripheral information in favor of current market news and trends, and both strategies are dictated by emotion-less mental focus.
However, there is one major difference between the two factions. Unlike trend traders, that tend to build their strategy around long-term trends, momentum traders live on the edge where day traders dwell. Rather than a slow and steady burn, momentum traders prefer their actions to be fast and furious, deploying a “buy high, sell higher” strategy that seems a bit on the wild side for some traditionally conservative trading tropes.
The Secret Behind Successful Momentum Traders
Momentum trading is where only the stock market strong survive. Massive quantities of patience, discipline, and focus are needed to achieve the type of success desired to make this type of trading worthwhile. It also demands a special combination of fundamental and technical analytical prowess to efficiently detect and work with stocks that best fit the traders’ daily endgame strategy.
For a momentum trader, the technical analysis is achieved by predicting a certain financial instrument being either higher or lower than it should be, which would allow them to make money by shorting now and buying later in a higher situation or vice versa in a lower situation. Conversely, a fundamental analysis will lead the trader to make decisions based on market volatility. In this branch of analysis, news derived from various happenings or incidents over the course of a day play a large part in what the trader does.
The Strategies of a Momentum Trader
Perhaps the most important aspect of momentum trader strategy is to pay attention to the emotions of other players in the market before pulling the trigger on the stock. Obviously, stocks with lots of volatility are going to have a lot of factor driving their action. It’s up to the momentum trader to discern stocks that are moving for the “right reasons,” and not just because the market is acting out of panic, fear, or even abject greed.
It’s also important that a momentum trader’s personal emotions don’t get in the way of their own strategy. Momentum traders will have an exit strategy of sorts when it comes to selling or purchasing stocks. Ideally, this strategy revolves around the concept of taking advantage of a stock’s positive volatility at its optimum time. This particular strategy requires a shutdown of the emotional responses that may cause the trader to sell early, before the endgame brought about by prediction is reached.
Of course, there are a few things that momentum traders must do to create this strategy. For one thing, they will usually have a few stocks circled as potential huge movers and will use all sorts of media to follow their movements, from television to online message boards. Secondly, momentum traders will pay close attention to a stock’s volume, honing in on their resistance levels to ensure they aren’t making noise for ultimately irrelevant reasons. They’ll also turn to technical indicators to help them determine the optimum points for buying or selling.
Even tough discipline and knowing when to stay in are key components to a solid momentum trading strategy, it’s equally vital for them to take a conservative approach; one that leads them to knowingly duck out of their stock of choice right before things start going south. Granted, this can be tough to predict, and admittedly the ability to do this consistently lay in that ethereal gap that separates art and luck. With that being said, savvy momentum traders do know how to make the luck part of the equation dwarfed by the artistic side.
One of the ways they do this is by limiting their trading times. Typically, momentum traders will restrict their times to the first hour and last hour of the day’s trading session. The reason for this is simple – those slots of time are when the market is at their most volatile. Conversely, seasoned momentum traders will reside themselves to the fact that the lunch hour can be a pretty rough affair.
Why Momentum Trading Works
The reason why momentum trading can be an effective strategy for a certain type of investor is the same basic reason why stocks work as a whole. That is, stocks that perform well – which are the stocks momentum traders solely focus on – tend to outclass the rest of the market. Theories abound why this metric is so consistent (company management is a big one), but in the end, the cause is irrelevant. What is relevant, however, is having a system that takes advantage of this market truism. Momentum traders have one of the best systems in place.
Not a Fool-Proof Strategy
Momentum trading is not without its pitfalls. Not so savvy traders may jump into a position too soon before a move is locked in (or, conversely, move in too late after a saturation point is reached). It can also be rather easy for those who have a slip in discipline to get duped by a stock that’s far less trendy than it may look like. They may also get into a mindset that a volatile stock may continue momentum the next morning; something that can have less than optimal results.
Still, for those that survive these lumps, learn from them, and move forward with a more refined discipline, momentum trading can be a very successful strategy to deploy. It’s a fast-moving strategy that keeps investors on their toes, but if we’re being honest, that’s part of the thrill.
8. KISS Traders
We all know that the acronym KISS stands for “Keep it simple, stupid!” As such, it may surprise some people to see that a thing called a KISS trader exists in the world of investment strategy. In this case the acronym is a bit of a misnomer. While the underlying principles that govern the KISS trading strategy are indeed rooted in simplicity, there isn’t anything stupid behind the strategy or its usage.
KISS is an acronym for the design principle "Keep it simple, Stupid,” meaning "Don't be stupid, keep it simple!". Other variations include "keep it short and simple" or "keep it simple and straightforward”. The KISS principle states that simplicity should be a key goal in design, and that unnecessary complexity should be avoided. - stockoptionsmadeeasy.com
The Art of Simplicity
If the term KISS trader appears to be too harsh, perhaps a better way to describe this type of trader is that they apply the philosophy of Occam’s Razor to the market. The backbone behind this classic motif is rooted in the concept that states “the simplest explanation is the best explanation.”
That’s essentially what KISS traders do. They carve the market down to its lowest common denominator so they can grasp an intimate knowledge of its basic machinations. The theory behind the strategy is that they will become experts on the market’s most basic principles, and use that advanced knowledge to their financial advantage.
Despite what the acronym may imply, the simplicity that governs the KISS trading principle is not rooted in stupidity. Successful KISS traders know that this does not give them free reign to turn a blind eye to analytics and indicators. However, the basic principles behind these essential strategic components will be broken down to their simplest terms. This reduction will allow a successful KISS trader to build a strategy around equally bare bones concepts, such as what and when to buy, when to put stop loss orders, when to claim profits, and risk management. KISS traders will typically exhibit solid discipline and keep on the straight and narrow when it comes to selection and application, as to minimize the risk of complicating things.
Seeing Profits and Loss with the KISS Trading Strategy
As previously mentioned, successfully adhering to the KISS trading strategy takes more than just buying a stock at one point and looking at the price in a few days. There is still a measure of analytics that needs to happen. Yet this measure of analytics doesn’t mean taking deep dives into the minutiae of stock market terminology. When boiled down to the basics – which are what the KISS strategy is all about – daresay analytics can become rather easy.
For example, let’s say a KISS trader purchases a stock. Over the course of a few days, a trend develops, and the parameters of this trend are broken out on an analytical chart. KISS traders can hone in on the stock’s line on the chart and pick out minimal information that translates to positive or negative movement.
The price action is the most obvious metric to detect in this situation. After all, it’s pretty to see a stock’s chart line rising upward from the stock purchase point and ascertain that the stock has made a profit. However, other metrics are just as easy to spot on the chart, such as support and resistance levels, chart patterns, trend lines and volumes. The successful KISS trader will have a strong working knowledge on these particular metrics, and will be able to apply this knowledge to gauge the stock’s profitability. These analytics can also be applied to help deduce solid entry points to purchase a stock.
The Individual Complexity Behind Simplicity
While simplicity is the prime mover behind the KISS trading strategy, this doesn’t mean that the methods behind buying and selling stock are completely uniform. As is the case with other types of market strategy, the KISS trading method is built on how investors interpret the market. This interpretation is not strictly governed by outside sources establishing parameters that dictate perfect buying and selling moments. These parameters are wholly set up by the individual.
The principle of KISS trading is one that pits the market philosophies of traders against those interpreting the market’s action differently. If you apply Occam’s Razor to this sentiment, it boils down to the notion that there is a seller for every buyer. At best, the KISS trader will aim to be on the right side of that particular equation.
When it comes to the stock market, the buyer or the seller isn’t correct. The markets are the ones that are correct. If KISS traders end up being underwater on an investment, they are not the cause of why the loss occurred. They simply misinterpreted the market’s course.
Responding vs. Reacting
The actions that successful KISS traders take are pretty uncomplicated. They don’t react to what the market is doing by making on-the-fly decisions that could potentially complicate matters. They simply respond to the market action. If they notice the price is going up, they’ll stick with it until it stops rising. Conversely, if the price is going down, they’ll stick with it until it stops dropping. This is dictated by the direction of whatever trading strategy the KISS trader has taken on, like put options. To put it in simpler ways, KISS traders won’t freak out over market trends – doing so would make it harder to accomplish things.
Keeping Things Simple is Smart
By deploying a simple, steady strategy, KISS traders avoid a lot of the pitfalls that many professional traders risk doing. By staying on the straight and narrow, they avoid digging into new trading techniques, which means that they skip out on having to figure out their various complexities. While these techniques may be sophisticated and could yield more efficient profits, they could also result in some pretty bad results, particularly if they use language that requires a deviation from simple terms and analysis. In other words, it could be a good way for someone invested in the KISS method to lose money.
That’s why KISS trading can be so advantageous, particularly for those that don’t have the time or patience to gain an advanced knowledge on advanced concepts. By being able to spot market action in a simple way, they can spot the simplest trades and act on this accordingly. In the grand scheme of things, there’s nothing stupid about that.
9. Futures Traders
There is an undercurrent of predictability that makes the stock market hum. This sentiment is the backbone of the philosophy of “buy low, sell high.” In a way, futures traders tend to turn this principle on its ear, because their mantra can be interpreted as “buy when a certain stock gets to X and sell high.”
The Four Types of Futures Traders
At its core, the concept of futures trading is built around a financial contract giving a buyer an obligation to buying an asset at a fixed price at a future point in time. These contracts, also known as futures contracts, always must feature a buyer and a seller to make it work. Consequently, this turns this trading practice into a zero-sum game, meaning that in each transaction, there will be a person that gains and a person that loses.
There are four different kinds of futures traders on the market. While they collectively make up the liquid futures trading market that exists in the market, they all approach the creation of this market in different ways. These classifications are not based on the actual trading strategy. Rather, they’re built on the impetus behind their trades. This makes a lot of sense – after all, the endgame of any futures trader is to turn a profit
The first type of futures trader is known as a hedger. These traders go about their business by going short on futures contracts while at the same time owning the underlying asset or other futures contracts of the same or related underlying to protect themselves from price fluctuations that could have an adverse impact of existing positions. In other words, these are the types of futures traders that “hedge their bets.”
The second type of futures traders, speculators, is representative of the crux of the trading market. Their method of operation is built on providing activity in the futures market via day trading or swing trading strategies, snapping up or jettisoning futures contracts outright so they can speculate on what may look like a strong directional move. While it may be the most popular form of the futures trading market, it is also the riskiest, as a speculation that falls short could have some pretty dire consequences.
The third type of futures traders are arbitrageurs. This fancy-sounding word describes traders that are in the futures game to pick out price anomalies that exist between futures contracts and underlying assets for the purposes of mitigating, if not outright eliminating, the risk involved. This practice does provide a ton of volume and liquidity to the market because its practitioners are typically just interested in working with big funds and big trading volumes in order to gain the biggest profits possible. It may also be the most competitive form of futures trading on the market, something that may correlate to the advent of computer programs built specifically to scour the market and perform these types of transactions on behalf of the trader automatically.
The fourth group of futures traders, spreaders, specializes in trading futures contracts along with other futures contracts or underlying assets in a package deal of sorts, as a means to lower risk and elongate profitability. This package deal is complex in nature, and it’s a relatively new way of trading futures, as it’s only been made known to the general public in recent years.
How Do Future Traders Work?
Typically, the types of assets traded in futures are linked to commodities, stocks, and bonds. These can encompass a wide range of industries and elements, from grain, electricity, natural gas, foreign currencies, and even bandwidth.
If a futures trader is a hedger they won’t seek a profit by dealing with commodities. Rather, they will try to stabilize the costs or revenues of their business operations. The gains and losses that are incurred are typically balanced by a corresponding loss or gain within the market for the underlying physical commodity.
Speculators, on the other hand, generally have no interest in grabbing hold of the underlying assets. They typically place bets on the future prices of certain commodities. Because of this, if they don’t agree if a price of a particular commodity is going to fall as per the general consensus, they’ll consider snapping up a futures contract. If their sentiment turns out to be correct they can make money by selling the futures contact at a substantial uptick in price before it expires. Selling the contract will also prevent them from having to take the delivery of the commodity.
The actions that a speculator can take in this setting tend to create enemies in certain parts of the market, as they are often blamed for big price swings. However, they provide the market with a valuable service, in the sense that they provide it with liquidity in the futures market.
Regardless of the futures traders approach, the contracts that are signed are all standardized. What this means is, the contracts will all specify the quality of the underlying commodity, how much it is, and the delivery. This ensures that the prices are uniform across the board to everyone in the market. This helps to level the playing field and eliminates the guesswork that may otherwise be present in these situations.
The Bottom Line about Futures Trading
Again, futures trading is known as a zero sum game. If someone makes a profit of X amount of dollars, someone is going to take a loss of that same number of dollars. This may seem like a brutal way to go about doing things, but it is still a practice that contributes essential market liquidity. It’s also an attractive option for those that have the funds. After all, the contracts can be purchased on margin, which allows the trader to buy a contract with a partial broker loan. If and when the trade hits big, the futures traders could stand to make a nice chunk of change with what amounts to be very little of their own money. Because it’s a zero-sum game, this type of trading may be a bit scary. However, for those that have the intestinal fortitude, it could be an irresistible way to trade.
10. Forex Traders
The ups and downs of the stock market move well beyond Wall Street. It’s a global entity. Foreign exchange traders, better known as Forex traders, are well aware of this, as the group consists of traders that work to make profits from buying and selling currencies of all stripes on the foreign exchange market. While it may feel a little exotic when filtered through domestic eyes, it’s really not. In fact, from a global perspective, you can make an argument that it’s a prime mover in the global market.
A Look at Forex Trading
If your trading is solely focused on domestic properties, you may not realize the massive size of Forex. However, the Forex market (sometimes known as the FX market) is the globe’s largest financial market, and the amount that’s traded on it is greater than all of the world’s combined equity markets. The big difference between Forex trading and stock trading is the fact that traders are speculating on the values of currencies instead of stocks, and they ultimately make their profits from correctly predicting exchange rates. However, when you strip the actual element being traded, you’ll notice that there are a lot of similar elements in play within the Forex market. For instance, the Forex market is based on a volatile, auction-based system. While everyone is gunning for profits, there is a firm understanding that there is risk involved, and a high risk at that.
With that being said, there are fundamental differences that make Forex trading attractive. The primary allure stems from the fact that, because it’s a global market, Forex never closes. All of the markets that are collectively found under Forex do have set hours, but you will always be able to find a location that is conducting some action whenever you log onto your computer. To paraphrase the old song lyric, it’s between the hours of 9:30 and 4:00 PM somewhere.
The proliferation of the internet has also created the biggest paradigm shift in the Forex market. Prior to the web, Forex trading was pretty much limited to professional investors and their ilk. Yet the incomparable access that the Internet allows all of its denizens has opened Forex to all people from all corners of the world.
What Kind of People are Forex Traders?
As the infiltration of Forex trading platforms continues to penetrate the retail market, there have been two types of Forex traders that have emerged. The first type of traders is the ones that work with a broker. These are the traders that use brokers as agents that try to find the best price in the market, acting in the trader’s best interest. In exchange for the work, the broker will charge the trader a commission in addition to the price gathered in the market. Not surprisingly, the presence of this type of traders has grown with the advent of the proliferation of the retail sector.
The second type of trades is called market makers, primarily because they are known to “make the market” for the trader and act as the transaction negotiator of sorts. They do their business by quoting the price they are willing to negotiate at, and are compensated via the spread (that is, the difference between the buy and sell price).
The Advantages of Forex Trading
Forex makes for an attractive trading option because it is so big. Daily volumes on the market typically exceed $3 trillion. This means that there is a huge amount of liquidity afoot in the market, and this hefty volume makes it easy for traders to jump in and out of position. Plus, traders have the freedom to make these jumps around the clock. There is no such thing as an opening or closing bell in the Forex market; just the ability to try and gain profit around the clock, with the exception of a few weekend hours.
Another advantage to Forex trading is that the market seems custom made for 21st century technology. It’s very easy for a Forex trader to hop online and get involved in the process. This includes funding their trading account for as little as $250 per day. What’s more, many brokers will allow retail traders to jump into the game the same day their accounts are funded.
Even though Forex traders are dealing with a global market, there are still fewer things to analyze. Because Forex is solely concentrated on currency exchanges, the Forex trader doesn’t have to deal with analyzing thousands upon thousands of stocks to find something that works. This helps cut down the feeling of “drowning” in stocks quite significantly.
The sheer volatility of the Forex market also makes it possible for Forex traders to turn profits in any market condition. What’s more there isn’t any structural market bias like the long bias you may see in the stock market. This means that traders will have n equal opportunity to profit in good and bad markets.
Remember – Forex Trading Carries Risk
Because of all the good things Forex has going for it – easy access, round-the-clock-trading, simplicity in the number of trading options – it may seem like it’s a market that’s ripe for plunder at the snap of a fingers. Yet it’s important to remember that the Forex market, just like any other market, is a volatile one that has its own unique set of risks. In other words, if you become a Forex trader solely because you think it’s easy market money, you may be in for a rude awakening.
Still, all of the aforementioned metrics that are associated with Forex trading make it an attractive market option for traders that approach entry into the market with the appropriate amount of caution. And as technology continues to progress and shrink our world down to sizes unimaginable even twenty years ago, there’s every reason to believe that the concept of trading on the Forex market is going to increase in popularity. After all, even the most refined trader has to acknowledge that making a trade from your PC right before you go to bed seems like a pretty cool idea.
11. Day Traders
In some respects, day traders are the mavericks of the investment world. This is especially the case when the practice is viewed outside of Wall Street, where they could be looked at as extreme risk takers akin to gamblers that sit down at the average Vegas blackjack table. However, the activities of a day trader demand much more respect than a base comparison to a game of Twenty-One.
Day Traders Defined (and Re-Defined)
At its most basic level, day traders are indeed those that enter and leave positions on the market several times throughout the investment day. Furthermore, they never will close out the day with a position in hand – overnights are a no-no.
Yet perhaps the best way to describe these trader types is to call them an intra-day trader. After all, these investors aren’t putting all of their eggs in one basket every day. They are jumping in and out of position on different trades, thus making the practice a lot more strategic and a lot less like the “get rich quick” scheme that it may appear to be to people outside of Wall Street.
With that being said, there is an admitted air of maverick-like behavior to the practice. Indeed, it is within the realm of possibility for a day trader to purchase a stock and sell it off in a matter of minutes if not seconds if the resultant profit would be deemed satisfactory. It’s also possible for day traders to buy and sell the same stock several times throughout the day.
The only trading activity verboten in this game of Wall Street hot potato is keeping the purchased stock overnight. This is mainly done to avoid the very real possibility of the stock opening at a price lower than what it closed at the previous day. While this so-called market gap down may not be a big deal for trading types in it for the long haul like buy and hold traders, such a situation is anathema for the day trader.
"pattern day trader," which includes any margin customer that day trades (buys then sells or sells short then buys the same security on the same day) four or more times in five business days, provided the number of day trades are more than six percent of the customer's total trading activity for that same five-day period. Under the rules, a pattern day trader must maintain minimum equity of $25,000 on any day that the customer day trades. - finra.org
The Types of Day Traders
There are essentially two kinds of day traders that proliferates the market: Institutional day traders and retail day traders. The one common thread that links the two day trading camps together is that they are described as speculators, no investors.
As the term implies, institutional day traders work for financial institutions. This gives them an advantage in the sense that they have a greater range of access to tools, capital, leverage, fresh fund inflows for trading purposes, state-of-the-art analytical software and more. These advantages give them the edge over their retail day trading counterparts, because they can use these tools to enjoy a more efficient, if not more intuitive, day trading experiences.
Retail day traders, on the other hand, work either by themselves or via a partnership with a few other traders. They tend to trade their own capital, although trading with other people’s money isn’t out of the question. Typically, these types of day traders will utilize direct access brokers, since they offer the fastest order entry to exchanges.
The Advantages of Day Trading
The endgame of a day trader is to make profits off of small price movements in highly liquid indexes or stocks. As such, it doesn’t take much volatility for a day trader to find an agreeable profit, even though a volatile market will obviously present itself with more opportunities for financial gain.
The microscopic time frames that day traders deal with provide them with perhaps their biggest advantage; namely, adaptability. Because they aren’t married to stocks in the long-term like, say, a buy and hold trader, day traders have the freedom to jump in and out of various positions in ways that ideally coincide with the way the market is working.
Plus, with the right amount of disciplined rules in place, day traders can turn this wild-looking form of trading into something that plays conservatively. By utilizing essential trading rules like setting time limits on the development of trading range, sticking to a predetermined profit target and putting strict stop loss orders in place can go a long way into minimizing risk.
The Commitment to Being a Day Trader
In some circles day trading seems to have this air of being ideal for the average schmoe that views the practice as a casual way to turn one dollar into two. Despite the romance associated with such a mindset, nothing can be further from the reality of day trading. To be a successful day trader, a person needs to be willing and able to set aside a substantial amount of time every day to tracking the market. This type of trading should never be treated as a hobby. For those invested in the practice, it’s a full-time job. Traders are virtually tethered to their computer all day, buying and selling socks from the moment the market opens to the time it closes. Treating this practice as a fun little activity to do on occasion is probably going to grow much less fun in a hurry from a financial standpoint.
Day trading also requires a substantial amount of discipline. Because the practice is largely based on analytical metrics, day trading leaves little room for emotions that may be common on the market, such as panic when a stock takes a dive. This may seem counter-intuitive given the number of times day traders may jump in and out of positions during the course of a day, but it could spell the difference between a profit spurred on by cold analytics and rules and a loss driven by the hope of an end-of-the-day recovery.
A Good Strategy for the Right Investor
While day trading may look like a rollicking good time on paper, it’s really a serious form of investment designed for those that are committed to daily analysis and strong rule-driven discipline. These metrics certainly run counter to the notion of the practice being the investment equivalent of a Sin City gaming table. Yet when done properly, this form of investment may end up producing much better results than your average roulette wheel.
12. Contrarian Traders
Typically, trader types will base their investment strategies around whatever prevailing trends are floating around the market. Contrarian traders aren’t one of these trader types. They are the salmon of the investment world, swimming upstream against the flow of market trends by picking up poorly performing stocks and selling them off when they perform well. It seems counter-intuitive on paper, but there is indeed some method to their madness.
The Schematics of Contrarian Traders
Contrarian traders run on the notion of verbal context. They tend to believe the pundits tout upwardly mobile trade trends when they are full invested, and predict market tumbles when sales have already occurred. In other words, they kind of view investors that fully follow trend-fueled advice as sheep destined to be converted into lamb cutlets. They view extreme lows and highs as misguided numbers whose course correction is a concrete inevitability. Their strategy is to wholly take advantage of the gaps that develop between the extremes and what they deem to be the future “new normal.”
With that being said, this doesn’t mean that they hold contempt for the stocks or the investors that are driving up the price. They simply believe that the two have collaborated to cause a price in need of correction. Contrarian traders spot these trends by finding stocks whose trend tendencies seem to be surrounded by a gathering cloud of pessimism.
For the contrarian investor, this pessimism will eventually influence the direction of the stock. Once this influence hits, the action that drives the interest of the contrarian investor can move very swiftly. The speed of these transactions, coupled with the fact that going against a price trend is not an easy task, makes this particular investment strategy a difficult endeavor.
The Mechanics of Contrarian Trading
Given the tricky nature of contrarian trading, it’s not too surprising to see that undergoing the practice is somewhat labor intensive. Successful contrarian traders will constantly dig into intense market monitoring, keeping up with as much stock-related news as possible to spot stocks that are prime targets for their strategy.
There are a few tactics that contrarian trainers will utilize in conjunction with this research to find success in their methodology. Firstly, they will lean on the buy, hold, or sell recommendations extracted from various analyst ratings. If they see a discrepancy develop between a trending stock and the number of “buy” recommendations, they may put themselves in a position to pounce on the stock.
Contrarian traders will also turn to shorting a stock or buying put options when a stock’s price tumbles. Scrutinizing changes in short interest and put buying builds quantitative data regarding a stock’s negative sentiment. If a large amount of said sentiment is detected even as the stock price is continuing to increase, contrarian traders and make the assumption that there’s plenty of money on the sidelines that can keep momentum going. This in turn makes it a bit easier to spot ideal times to go against the grain.
If you want to quantify the actions of contrarian traders in non-financial terms, you can do so by stating that these trader types thrive on the emotions of investors. They hold the sentiment that massive upswings or downswings are caused by high greed or fear on a group level. This somewhat mild form of mass euphoria (or hysteria, if the market is plummeting) is a beautiful sight for contrarian traders to behold, because in their view, the time to earn a profit is best when the market appears to be at its worst.
Some of the indicators that contrarian traders tend to use feed on this sentiment rather strongly. For instance, the volatility index, or VIX, can be a contrarian trader’s best friend. Also known as the “Fear Gauge,” this indicator calculates the inputs from various call and put options and builds a 30-day projection of implied volatility relating to an approximation of the S&P 500 index. This approximation will provide the contrarian trader with solid clues on what stocks people are poised to freak out about one way or another.
Another key indicator stems from the old cliché “actions speak louder than words.” While talking heads will provide clues on market action, any data that contrarian traders can mine regarding measurable indicators will carry a substantial amount of extra weight.
The Success of Contrarian Traders
History has shown that contrarian trading can produce fantastic financial results. The famous banking family the Rothschilds made a killing by adhering to the principles behind the trade’s sentiment. However, being a successful contrarian trader goes beyond merely going against the market’s grain.
A successful contrarian trader will firstly realize that there is usually a noticeable difference between opinion and action, and this correlates to a variance of sentiment. In other words, it’s imperative to follow the money and confirm essential things like price and not take verbal sentiment at face value.
This seems like a no-brainer, but it should be emphasized. After all, opinion may be strongly tied to emotion. In the situations targeted by contrarian traders, these emotions may run a little more askew, as greed and fear may ratchet up the opinion’s intensity by a considerable measure. Taking a look at things from an analytical perspective will give contrarian traders the real story, not the tall tale.
There are also some risks that go along with contrarian trading, even if you’re disciplined enough to just take opinions as opinions. Remember, this particular form of trading can be rather difficult, because it’s oftentimes not enough to act on what the market is doing. It’s important to act on why the market is doing what it’s doing. The lines between the what and the why can be easily blurred for the investors, which could cause problems.
Even with these risks present, a diligent contrarian trader can use the high highs and the low lows of the market to their advantage and earn a nice chunk of change. It’s a practice that will never go out of style, either. After all, greed and panic will always be emotional pillars of the stock market as long as the opening bell continues to ring.
13. Buy and Hold Traders
In the world of trading, sometimes it’s best to cut to the chase. That seems to be behind the term describing buy and hold traders. After all, their investing calling card is to snap up stocks and hold onto them for a long group of time. In a world where day trading and even swing traders seem to snap up all the investment-related headlines, the apparent lack of flash associated with buy and hold traders makes them almost seem antiquated. However, this is a false perception.
In fact, buy and hold traders are believed to be the largest group of people that are buying stocks. The reason for this is most likely due to the fact that buy and hold trading requires a minimal amount of time having to hone in on the stock market, especially in relation to swing traders and day traders.
The Philosophy Behind Buy and Hold Trading
The mindset of a typical buy and hold trader is one that tends to be consistent with what people may consider to be a traditional stock market investment strategy. Classic buy and hold trading consists of snapping up stock from great, “blue chip” companies and holding on to them through thick and thin. They’re truly in it for the long haul, and this strategy of hanging on to stock for years means that they are likely to completely avoid trendy businesses and emerging companies that may constitute a high-risk.
The Pluses Behind Buy and Hold Trading
Deploying a buy and hold strategy may be viewed as passive by day or swing trading standards. However, there are definite advantages to the technique that make it an attractive, if not a tried and true, option.
The biggest advantage is that it tends to be significantly less nerve-wracking for the investor. After all, the strategy’s main impetus is to invest in less volatile stocks. Those that utilize the technique will be unfazed by short-term fluctuations, because their goal is to watch their purchase mature and profit over a much larger period of time. In other words, they’re less likely to freak out if a particular stock takes a hit in the span of a couple days. This also means that there is a lot less maintenance to deal with. The buy and hold trader won’t have to worry about spending the day constantly tracking stock movements, because their strategy isn’t necessarily built on catching a stock upswing at the perfect time of day.
The nature of buy and hold trading – that is, to buy a stock and hold on to it as it matures over time – means that the investor deploying the strategy won’t spend nearly as much money on fees and commissions. These costs are something that tends to get glossed over by those that trade with small amounts of cash, as they tend to erode at a person’s overall profit margin. By minimizing these fees, it’s believed by many that buy and hold traders make more money over time.
Buy and hold traders can also experience the singular thrill of watching their net investment uniquely grow through dividends and bonuses as the company they’ve invested in grows. This is a unique thrill that is not all that readily available to the day trader or swing trader, who is not likely to stick around for such things to occur. There are also tax advantages to the buy and hold strategy, as they have the ability to defer capital gains taxes while the investment grows.
Finally, a buy and hold strategy is appealing because it works. History shows that even though the bear market takes the occasional swipe, the market as a whole has produced a 9% annualized return over the stretch of 100 years. As the old saying goes, “slow and steady wins the race.”
The Downside of the Buy and Hold Strategy
Just because a buy and hold strategy minimizes the risks typically associated with day trading and swing trading, this doesn’t mean that the technique is infallible. Remember, in the stock market, no strategy is immune to risk. This risk doesn’t just constitute a long-term loss; it could also be indicative of a lower-than-expected return.
It’s also important to bear in mind that even in a long-term buy and hold strategy, timing is everything. If your endgame winds up being stuck in the throes of a bear market, you may have to adjust your timeline to avoid a loss or a minimal gain. The ability to predict the manifestation of a bear market may also require some pretty heavy analysis. This may be overwhelming to the investor – especially when you consider that the fundamentals that dictate the manifestation fluctuate over time due to political, technical, and socio-economic changes.
Of course, the underlying issue that buy and hold traders may face is the feeling that they’re missing out on all of the market’s short-term fun. Hanging on to a stock for the long-term can try your patience, particularly if you have colleagues making bank on short-term strategies. This patience has great potential to wear thin, which could result in the buy and hold investor making the decision to overtrade just so they could feel like they’re doing something.
When Does Buy and Hold Turn into a Must-Sell?
A buy and hold strategy’s endgame oftentimes will be put off for several years if not decades, until the investor retires. However, there are a few scenarios that could develop that make cashing out of the stock a fundamentally sound idea. These scenarios include a company filing for bankruptcy, a company’s CFO getting busted for various illicit accounting-based issues, or if a company that does something that doesn’t jibe well with the investor’s principles. While investors may be reluctant to play their hand in these situations, it may be the best move they have on the table.
A Traditional Strategy that Works
When you strip away the various terminologies, it’s clear that the buy and hold strategy is another method of long-term investment. This has been the backbone of the market for years; driven by small investors that don’t have the patience required to learn market analysis or the terms and methods required to be successful in the market beyond the blue chips. It’s the ultimate example of “buy low, sell high” from a historical standpoint, and it will most likely continue to be as long as the bell on Wall Street chimes.
14. Break-out Traders
Break-out Traders tend to be lumped into the same category as range-bound traders and channel traders, and with good reason. After all, the three groups all share a basic strategic motif – that is, the reliance on a trade being harnessed by a couple of fairly recognizable lines. However, break-out traders contain enough variation within their strategy to differentiate themselves from the other two strategies. It’s a differentiation that manifests in its very name.
What are Break-out Traders?
As the name implies, break-out traders are those that seek out and buy strong stocks that have just broken out. They will follow up on this stock because, when a stock breaks out, they typically emit an alluring buy signal. This is particularly the case in a bull market where there’s not as much trepidation about the stock crashing. During these times, break-out traders may find stocks that can move massive quantities in a short time frame.
In order to be successful, break-out traders will have their own personally cobbled set of rules to determine if a particular breakout stock is worth pursuing. These parameters oftentimes feature the inclusion of fundamental analysis and other similar metrics to separate the sheep from the goats.
They are also able to use the various signals emitted by breakout stocks to limit risks and be at the right place at the right time, thus allowing them to swoop in and capture substantial price moves before other traders develop the wherewithal to realize that a new trend is afoot.
What’s a Breakout Trade?
Before defining a breakout trade, it’s important to define a breakout. This term represents a stock price that jumps past predetermined support or resistant levels. When prices move above the resistance level a long position is triggered. Conversely, when prices fall below a clearly defined level of support, a short position is triggered.
These breaks are not that common, and they usually are accompanied by a good measure of surprise. As such, they tend to catch your average trader off-guard, thus increasing volatility and consequently the break-out. These are obviously the instances break-out traders seek. Because they are hyper-focused on finding these types of stocks, they can be relatively easy pickings for those that know what they’re doing.
While breakouts can occur at any time, long-term breakouts tend to create more substantial changes in volatility and momentum. This may be construed to mean a higher level of forecasting ability and successful trading could apply. With that being said, breakouts that are seen on a daily or monthly basis typically have a higher probability of showcasing truer changes in underlying trends, which may give them a higher sense of validity.
The Strategy Behind Break-out Trading
The main goal that drives break-out traders is being able to enter a long position once the stock price breaks above resistance or enters a short position once a stock breaks below the support. Once this occurs, prices tend to trend in the breakout’s direction. Successful break-out traders use these points to set up future volatility increases and bigger price fluctuations. Oftentimes, these breakouts are the origin points for major price trends.
It’s important for break-out traders to pay attention to the stock’s support and resistance levels. The more the stock touches these levels, the more legit the levels become. This legitimacy increases their importance, which typically correlates to a more positive outcome once the breakout occurs.
Ideally, break-out traders will wait for horizontal channeling to occur; a channel in which support and resistance levels is more evident to traders. In this scenario, traders are tested because they have placed their limit orders below the line of support and above the line of resistance. Ultimately, limit orders are filled when the price breaks through this level, which results in an uptick in volume.
There is a specific methodology break-out traders will deploy in order to get this strategy to work cohesively. They will generally scan for stocks that indicate the following metrics:
- They will have a Bollinger Band width index of three or less. Ideally, they’ll have less with a candlestick count of at least 20, and preferably more.
- A low volume that indicates great potential to “blow up.”
- An indication that the 5-, 10-, and 20-day EMAs have really converged.
- They have defined support and resistance.
- Periods where the average directional movement (ADX) has breached below a particular threshold level.
- A generally narrow trading range over a defined unit of time is clearly detectable.
- They possess a visible sequence of at least three bars where the market closes within a prior bar’s range.
It’s important to note that these indicators don’t automatically provide profitability for a break-out trader. They must tailor their own protocols to successfully find breakout stocks that best suit their overall investment strategy.
Break-out Traders and Psychology
There is a great deal of mental wherewithal that goes into the art of break-out trading. After all, when stocks are trending upward, people are always buying shares. Break-out traders can find great success in this regard simply by being patient and waiting for emotion to take over.
When a stock starts going south, there may be plenty of people that hang on to the stock, hopeful that the stock will bounce back. If it doesn’t, the goal of these people may be to sell their stock just so they can break even. When this happens, break-out traders can predictably pick and choose the stocks that have fallen back to the pack, but are poised for another breakout.
Ultimately, the success in break-out trading stems from seeing a continuation or a follow-through of price activity in the direct of a particular break. This could be a break of resistance for a long trade, or it could be a break of support for a short trade. Without this momentum, the break-out traders may end up out of position.
Breakout-traders do require a little more hands-on knowledge of certain market-driven metrics to be a successful strategy. However, for traders that are able to digest these metrics, it can be an effective, if not sneaky, way to turn a profit.