Five trading strategies and how to choose the right one for you

If you feel you have mastered the concepts of investing, stockpicking and general portfolio-building, then perhaps it’s time to consider trading.

There are lots of ways to do this, with a number of trading strategies you might want to follow, comprising different skill sets and levels of analysis. Generally though, a trading strategy is a broad methodology to trading financial markets, whether its stocks, bonds, currencies or commodities – or anything that can be traded on an exchange.

Here, Telegraph Money, explains what strategies are out there, so you can see if they might suit you.

Trading is, fundamentally, all about market analysis – split broadly into both technical (interpreting charts, patterns and technical indicators as a predictor of prices) and fundamental analysis (underlying drivers of the market, earnings, geopolitical events and macroeconomic shifts).

Strategies will typically focus on either technical or fundamental analysis, but the concepts are not exactly mutually exclusive, so a good understanding of both will only improve decision making.

Of course, the methodology is just one element. You’ll also need to consider price points for entry and exit, good risk management and timeframe for fleshing out your chosen strategy.

The following strategies are both well-documented and tested by those who have come before. The bounty of the internet and its plentiful supply of literature on the subject has made entering the world of trading as accessible as it has ever been.

1. Scalping

2. Day trading

3. Swing trading

4. Trend following

5. Arbitrage

Scalping, while crudely named, does what it says on the tin. This short-term strategy takes advantage of minor price movements through multiple small trades – meaning you’re able to effectively skim profit little and often. Its main points include the below.

• Quick-fire trades. The advantage here is the ability to hold the asset for minutes or even seconds to then take profit when the asset value moves in either direction. From the outside, these small trades may seem inconsequential, but to a scalper small profits can quickly compound into large gains.

• High-frequency trading. This is where you can make good gains, but be wary of high transaction costs eating into those gains through commissions and spreads.

• Good for currencies and stocks. Given the short holding period, currencies and stocks are best for this. Look for anything with high liquidity and frequent price movement.

• Needs constant monitoring. Of course, this isn’t a set-and-forget strategy, it needs constant monitoring and fast decision making, which requires good knowledge on what drives markets in different directions.

Perhaps the most well-known trading strategy, day trading is both popular and a good litmus test for future progression in trading. If you can successfully execute and take profit in a single trading session, then it bodes well for more long-term strategic plans.

• Fewer rules. While the other strategies have rules and parameters, this only stipulates time spent. Unconstrained, a day trader can combine technical and fundamental analysis to buy and sell assets in the same day.

• No overnight risk. By its nature, there’s no overnight risk associated with day trading. Your only concern is to try and find intra-day fluctuations in price and capitalise on those.

• Requires full focus. Day trading (of which scalping is an example) requires full focus during market hours, but it’s less about eeking out profit from minor price movements and more about trading the rise and falling markets over the course of the session. Although like scalping, anything highly liquid with a propensity for volatility is useful in day trading.

Moving up the longevity of the trading landscape now, swing trading involves holding a position over the course of a few days, possibly even weeks. The aim though is still the same, take advantage of price swings or upward/downward trends in the market.

Swing trading is an exercise in timing. You want to enter the position at the perfect point and exit at an equally perfect point between the peak and trough of an asset.

• Less frantic. Swing trading is relatively more measured and less frantic than day-trading, a trader can take their time with decisions without the pressure of fractional windows of opportunity.

• Requires technical analysis. Given the holding period – often extending over days or weeks – you need an even greater grasp of technical and fundamental analysis. You are also exposed to what I mentioned earlier – overnight risk. There is an element of control within a single session and I say this with quite a large dose of irony. But overnight trading is subject to lower liquidity, higher volatility and unfavourable news that could derail a position.

• Stocks and forex are also viable options here too. However, if you wanted to take a shot at broad-market exchange-traded funds (ETFs) or something showing a distinct trend, then that would also be suitable.

While swing trading takes advantage of the swing in a price, trend following seeks to ride a wave, or trend.

Whether it’s upward or downward, a piece of news, strong earnings figures or some other tailwind or headwind is carrying the price momentum to where traders can capitalise.

• No predictions necessary. By identifying and following trends in a given direction, trend followers can capitalise on substantial market moves. Other strategies try to predict price levels, whereas the trend follower is focused on direction of travel using technical indicators as a guide.

• Avoid short-term issues. By riding the trend you can avoid the short-term issues a scalper or swing trader would have to consider.

• Beware of “whipshaws”. One potential downside of trend following is that you could fall foul of something called a whipshaw, where strong signals encourage a trader to enter a position only to see the market move in the opposite direction. In sideways markets – that is when the price fluctuates between support and resistance levels – false signals can be generated, increasing the likelihood of a whipshaw.

For this strategy, seek large-cap, high-volume stocks with a strong track record and established price history. Also, commodities should be considered as gold, oil and gas prices tend to follow long-term patterns and trends.

Arbitrage involves exploiting price discrepancies between different markets. Simply, buying an asset in a market where it’s priced lower to subsequently sell at a higher price point in another market. For example, Stock A is trading at $50 on the New York Stock Exchange, yet simultaneously, trading at $50.05 on the London Stock Exchange.

• Risk-free profit. The key advantage is taking risk-free profit. A trader has high visibility of the price discrepancies in real-time and will act quickly in one to then exit in another. It’s not without risk, but considering other strategies in this list, an individual is operating with near perfect information of prices across markets.

• Speed. Speed is key here, and to exploit inefficiencies you need to spot them before the market corrects or catches up. Also, as the above example shows, a 5 cents profit on a trade won’t exactly shoot the lights out. Given the low margins on each trade, you would need a healthy pool of capital to generate substantial profits.

• Currencies. Forex trading is the most common arbitrage play, given that price discrepancies between common currency pairs or different brokers can often arise. I would even hesitate to say cryptocurrencies. Personally, I don’t believe it to be an investable asset class, but to trade? It can be as profitable as any other asset – albeit with far more opaqueness.

This comes down to a few essential factors: time, risk tolerance, capital, knowledge and personality.

As a rule of thumb, if you are a beginner with limited time, swing trading or trend following are the best options. It can be done part-time and the entry/exit signals are clearer than in other, more specialist areas of trading.

If, however, you have a higher risk tolerance and can dedicate your full attention to a strategy, then scalping or day trading might be more suitable – but be prepared to put in the hours studying the market and its signals.

Financially, a moderate pool of capital is needed to start in trend following and swing trading, given the larger trade sizes and holding periods but, of course, can create greater profit potential.

If you are more comfortable reading charts, patterns and interpreting technical indicators (such as moving averages, RSI or MACD) then scalping and trend following, or even momentum trading is more appropriate.

Although, if company valuations, financial reports and macro trends are easier to gauge for you, then swing trading, or even something such as value investing would be the desired option.

Don’t underestimate the human, emotional side of trading too. Quick decision-makers who prefer fast-paced environments and pressure can do well scalping and day trading.

If you know yourself well enough as one who is more patient, considered and analytical, then the longer holding period strategies such as swing trading or trend following may be best.

Assuming you understand the basics of your chosen strategy and have had practice in a simulated environment, known as paper trading.

From there, choose a trading platform that is registered, reliable, with competitive fees and a user-friendly platform. The last point is key, if you opt for a strategy that is fast-paced, you really need a navigable platform. Again, paper trading accounts are offered by major brokers and platforms so you can familiarise yourself with the site before committing your own capital.

Risk management is more important than the strategy itself and the golden rule is to start small and set clear entry, exit and stop losses. By starting small, traders can record the patterns and success of their trades and learn from mistakes before upping the stakes.

There is no definitive answer here. But all of the strategies listed here are amongst the most popular options for trading financial assets.

Day trading and scalping are probably the most well-known. In terms of the most accessible? Probably swing trading given its flexibility and reduced time relative to profitability.

As an extension of that, position trading, which I haven’t covered, is where traders hold positions for weeks, months or even years based on the same kind of analysis a swing trader would use. This strategy is an exercise in patience, conviction and ignoring outside noise.

Broken down, this represents:

• 3: Risk no more than 3pc of your capital per trade.

• 5: Aim for a 5pc return on each trade.

• 7: Maximum of seven trades at any given time.

Firstly, 3pc risk per trade is a common and well-established rule in managing risk while trading and is a good protection against excessive losses.

The 5pc return target is in line with aiming for consistent, moderate gains rather than taking excessive risks for large gains. Consistency, rather than a Hail Mary pass with little chance of success.

Finally, the seven-trade limit encourages traders to focus on quality trades rather than taking too many positions at once, which can have the dual effect of diluting attention and increasing risk.

Trading, in many ways, is a reflection of the self. You have to be honest about how well you can interpret markets and the signals others may not see. You have to be honest about how well you handle stress, can you stay composed while the market turns against you?

Investing, to a certain degree, removes that emotion. I can dispassionately review the investments in my Isa and Sipp, but as pieces to a portfolio, the individual funds play a role, no more than that.

If you can trade with a good grasp of technical and fundamental analysis and keep the powerful drivers of fear and greed at bay, then trading is almost certainly for you.

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