Trading in financial markets can be a daunting endeavor, especially for newcomers. Success in trading depends largely on the execution of the correct strategy. A trading strategy is a comprehensive plan that includes specific rules and guidelines for making investment decisions, aligning with financial goals, risk tolerance, and an individual's investment horizon. The choice of strategy plays an important role in the trading journey. Let's continue to explore some of the trading strategies. If you want to know how to create a trading strategy, we suggest you read the article How to Create a Trading Strategy.
Trend Tracking Strategy
A trend following strategy involves investing in market trends. This is based on the simple belief that “the process is your friend.” Traders who use this strategy buy assets when prices rise, and when they fall, they sell them in the hope that the trend will continue. This strategy is ideal for markets with strong and stable momentum in a certain direction. However, it can lead to losses in turbulent or lateral markets.
For example, let's say that a country's inflation statistics show that prices are rising. In this case, it means that the value of the currency has risen and its trend has gone up, and you can profit through this process.
Levels Failure Strategy
Failure strategy involves entering the market when the price crosses a certain resistance or support level. These are the levels that had already begun to reverse when the price reached it. The goal of traders who use the breakout strategy is to make a profit from volatility and increased volume, which often follows these breaking points. However, false failures can often result in losses.
For example, consider the EUR/USD currency pair. For several weeks, it trades between a fully defined range, for example between 1.1800 and 1.2000. A high level, 1.2000, acts as a 'resistance' level, while a low 1.1800 is considered a 'support' level. Traders are looking for the pair to break out of this range, which indicates a strong movement in one direction or the other.
As a forex trader, you are closely monitoring the EUR/USD pair by using a failure strategy. Then, after an announcement of a major economic indicator by the ECB, the price suddenly starts to rise and the EUR/USD pair crosses the resistance level of 1.2000.
If you interpret this as a failure, you decide to buy EUR/USD, with the expectation that the price will continue to rise now that it has crossed the resistance level. In a failure strategy, the previous resistance level can often turn into a new support level.
You set the profit limit at a level above the breaking point, for example at 1.2100, and the stop loss at a level just below the breaking point, for example at 1.1990. This way, you have a plan to guarantee your profit if the price continues to rise and limit your loss if the price falls below the breaking point.
After a while, the price will continue to rise and reach your profit stop level of 1.2100 and your trade will automatically close with a profit.
Momentum Trading Strategy
Momentum trading strategy involves buying assets that are rising at high volumes and that need to be sold after the price starts to fall or decrease in volume. This is based on the notion that moving assets tend to stay in motion. The main challenge here is the timing of the market, as the direction of movement can change quickly and without warning.
Consider the hypothetical case of a technology stock, TechABC. Let's say TechABC recently introduced groundbreaking technology that has the potential to revolutionize its industry. This news leads to a lot of positive publicity around the stock.
As a trader who uses a momentum trading strategy, you will notice that the price of TechABC is rising rapidly in high volume. This suggests that the market is responding positively to the news, with more investors buying stocks. This price increase coupled with high volumes is often a sign of strong momentum.
Trading Strategies Based on Fundamental Analysis
A fundamental trading strategy is based on the analysis of the intrinsic value of a company in the stock market or the economy of a country in the Forex market. Traders analyze factors such as company revenue, economic indicators, industry conditions, and geopolitical events. Although this strategy can provide strong long-term investment opportunities, it can be less effective in the short term due to the market's frequent reactions to news and events.
In the case of a hypothetical company, consider XYZ Inc., a technology company known for its innovative products and solutions. A fundamental trader is considering whether to open a long position at XYZ Inc. or Not?
As part of the underlying trading strategy, the trader starts by reviewing XYZ Inc.'s financial statements, which include balance sheets, profit and loss statements, and cash flow statements. These documents provide key insights into the company's financial health. In the Forex market analysis, you are looking at the state of a country's economy.
Swing Trading Strategy
Swing strategy involves trying to make a profit over a short to medium term period, usually a few days to weeks. This strategy requires patience and a strong understanding of technical analysis. However, gaps and sudden market changes can be risky for this strategy.
Scalping is a fast trading strategy in which traders aim to profit from small price changes and make dozens or hundreds of trades a day. This strategy can be profitable because of its abundance, but requires a significant time commitment and quick decision-making skills.
Choosing the right strategy
Choosing the right strategy depends on a variety of factors, including risk tolerance, time commitment, and personal trading goals. It's important to understand that no strategy guarantees success 100% of the time. Trading involves constant learning, testing, adapting, and, most importantly, discipline to adhere to your chosen strategy.
Understanding and executing trading strategies is crucial to the success of trading. Each strategy has its own unique advantages and disadvantages and performs best in specific market conditions. The key is to understand these strategies, apply them based on your individual business profile, learn and adapt constantly. Remember, the journey of trading is as relevant to the process as it is to profit.