A Complete Guide to Trading Strategies
A trading strategy is a systematic way of buying and selling financial instruments, based on your financial goals, your risk appetite, and market indicators.
Trading without a strategy is like throwing darts on a board, hoping one will stick. Without structure and direction, it’s easy to get lost in the numbers, or give in to emotional swings. Using trading strategies to guide your decision-making can help you steer through these situations with a level head.
This guide will answer the fundamental question: what are trading strategies? It will also provide examples of trading strategies used by professionals, and highlight the principles behind each one. If you want to add structure to your online trading activities, here’s what you need to know.
This article at a glance:
- Trading strategies bring structure to your trading decisions, based on your financial goals, your risk appetite, and market indicators.
- Most strategies revolve around identifying market patterns, such as trends or ranges.
- These patterns are identified through different indicators and analysis tools.
- Some traders also base their trading around news events.
- Trading strategies can be active, with several trades within a short period, such as day trading, swing trading or scalping.
- Trading strategies can also be more long term, such as position trading.
What are trading strategies?
A trading strategy is a systematic way of buying and selling financial instruments. It involves pre-defined rules set within a specific context. The system employed by a trader will vary according to the instrument being traded. Traders will also consider the market and their personal preferences when choosing a trading strategy.
Put simply, a trading strategy is all about structuring your trading decisions based on your financial goals, the instruments you wish to trade, your risk appetite, and the market indicators that are factored into your analysis.
While there are various types of trading strategies, they all rely on certain fundamental concepts. Let’s see how these concepts apply to an asset, such as gold.
Trend trading strategies come into play when prices are moving towards one direction — up or down — over a period of time. In this case, traders will trade in the direction of the trend, once they have identified uptrends or downtrends based on their analysis.
German DAX goes on a downtrend
If the trend line is bullish, or moving upwards, you buy the asset. If the trend line is bearish, you sell. The line of thinking here is that a trend will continue for a while once it’s been established. As the trading maxim goes, the trend is your friend (until it ends).
What this looks like: An uptrend is confirmed when it is creating higher highs and higher lows on a price chart. Vice versa for a down trend, it will create lower lows and lower highs. If you’re trading in a trend, you would wait for pull backs and look to enter in the direction of the trend.
Range trading strategies involve trading within a range that is defined by two price points. The strategy is based on the pattern of prices moving within a range for a period. In this case, the highest points to which prices could move is called the resistance, and the lowest price points form the support.
EUR/USD trades in a range
In range trading, the first step is to identify when prices are moving in a range for a specific period. Traders will then aim to trade based on how they think prices will rise or fall within that range, or when they expect prices to breach support and resistance levels.
What this looks like: The price of gold keeps fluctuating, but does not cross 1900 USD, and does not fall below 1750 USD for a period. Traders are likely to go long when the price is closer to the support line (1750 USD), and short when they are closer to the resistance levels (1900 USD).
Breakout trading strategies are useful when prices breach support or resistance levels to start forming a new trend. The basic premise here is that you’re waiting for the price to move outside of the trend. Put differently, breakout trading means to trade when the price “breaks out” from the support or resistance level. And when it breaks, it breaks impulsively.
Gold breaks out from the resistance level
For example, if the price of an asset had never been higher than 10 USD, this is its resistance level. You’d then wait for it to go higher than 10 USD before you decide to buy or sell. Going above the resistance level is known as a breakout. It’s the point at which the asset has become bullish and will reach new levels.
What this looks like: The price of gold breaks out from a previous resistance of 1900 USD, to reach 1930 USD. Traders would go long in this case, expecting the price to continue climbing. If it was the other way around, and the price breached the support level instead, they would go short. A breakout is the market showing you that it is ready to move in that direction.
Reverse trading strategies focus on points at which a price moves from one direction to another. This switching of the trend from one direction to another is known as a reversal.
German DAX reverse to a downtrend after steadily climbing
For instance, if the price was bullish and switched to a bearish trend, this would be the point of reversal where a trader may choose to sell. When a reversal continues for a while, it forms a new trend.
What this looks like: The price of gold trends upwards until 1900 USD, at which point the trend reverses after hitting resistance, and price gradually drops to form a new trend.
Financial markets are heavily influenced by news updates (and Twitter, if you’re Elon Musk). News serves as a near real time tip off of the various external conditions affecting instrument prices.
For instance, oil prices are heavily influenced by external conditions such as production, social instability, global demand, and since 2020, COVID-19 case spikes. Some traders keenly follow these developments in the news, aiming to trade based on how they think the news will affect a given instrument. The key here is timeliness — news alerts are most useful before the market has had a chance to respond to new developments.
What this looks like: Fears about inflation lead to a spike in demand for gold (popularly seen as a tool to hedge inflation), leading to a spike in its prices.
Here’s a tip — stay updated with our insights on how instruments respond to current world developments.
Types of trading strategies
Now that we’ve established the fundamental concepts that can guide your decisions, let’s look at some examples of trading strategies you can use when you buy and sell forex , commodities , equities , or other financial instruments.
Day trading is, as the name suggests, a strategy that takes place over the course of a day. It’s an active style of trading where you never hold a position overnight. You can with some brokers, but it could be a risky move, depending on the instruments you’re trading. For example, an opening gap in a stock market could lead to some serious losses, not to mention the fees your broker will charge you, or the chance of a margin call .
Like all active trading strategies, you need to constantly monitor the markets when you day trade. This means using technical indicators and charts on trading platforms such as MetaTrader. Day traders will also keep a watchlist of different assets under a given instrument that they would like to trade. As they get more familiar with these assets, their predictions and analysis also tend to improve.
Day traders are less concerned with news trading strategies, and more focused on finding short term patterns, such as trends or ranges, during which to trade.
Position trading takes its cues from trends, reversals, and breakouts. A trader will monitor price charts over an extended period of time, typically daily, weekly or monthly, and look for patterns based on which to trade. Once a trader has opened a position, they typically hold it for a while before they exit.
In this way, position traders aim to ride out the shorter upswings or downswings in the market for a longer pay off. This kind of trading is the opposite of what day traders do — position traders aim to hold just a handful of positions in a year. They are also not too concerned about short term changes in price, unless they believe that a particular market event could have longer term implications on their position.
This type of trading suits those who either don’t have the time, or don’t want to spend too much time at their desk analyzing the markets. Once a trade strategy is created, they stick to it.
Swing trading strategies are usually short-to-mid term propositions. They sit in between day trading and position trading. Swing traders typically aim to capture the different swings in prices occurring over a period of time. This means that swing traders will trade several times over weeks or months, unlike day traders who place multiple trades within a day, or position traders who hold a long or short position for a long period of time.
Swing trading is a more hands off trading strategy, focused on identifying upswings and downswings wherever the trader is able to. So while swing traders may make a handful of trades during a period, there may be days where they may not open a position at all.
Scalping is the process of exploiting imbalances in the supply and demand for a security in the very short term. By short term, we mean time frames that can be as short as a minute! These imbalances can make the bid-ask spread (the difference between the asking or selling price, and the purchasing or buying price) wider or narrower. It’s important for scalpers to avoid wider spreads as this can have a direct impact on their profit and loss.
This type of trading is more or less seen as a subset of day trading. Being able to read the market and time these trades can be tricky. This is why scalpers are often experienced traders that rely on trading algorithms and software.
We’ve given you examples of trading strategies and their fundamentals. The ones you choose will be a matter of personal preference. You can create a demo trading account with us in order to find the types of trading strategy that suits you.
Regardless of whether you employ an active strategy or hold positions for longer periods of time, the amount you risk should always align with your bankroll limits. Once you find the right balance between the amount you’re investing and the risk you’re willing to take, you stand a better chance of making a profit.
Of course, nothing is ever guaranteed, regardless of the trading strategy you use. Losses are likely to happen no matter how good your strategy is, especially if you’ve only just begun to trade. Strategy, after all, is no replacement for experience. At the same time, if you train yourself to trade strategically even as a beginner, you’re much more likely to thank yourself in the long run.
Trading strategies FAQs
What is the best trading strategy?
The best trading strategies are the ones that allow you to manage risk in a way that suits you. A crucial concept in trading is managing your money based on your personal limits and the amount of risk you’re willing to accept.
What is the best trading strategy for beginners?
Trend trading strategies are a good way to start because they only require you to look for a single point of significance. In other words, you have to identify a positive or negative trend and follow it.
Will I make money with trading strategies?
No trading strategy guarantees you a return on your investment. Trading can be volatile, and you can incur losses. However, a trading strategy gives you a system and structure to follow which, in turn, can help you make better decisions.
How to choose the right trading strategy?
Choosing the right trading strategy depends on how the market is trading, and what indicators and analysis can back your assessment of it. Your decision will depend on identifying whether prices are trending, trading in a range, reversing or breaking out. The more you familiarize yourself with indicators and analytical techniques, the better you will get at identifying these patterns.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorized to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.