Trading is the central activity in all markets, be it the forex, commodities, equities or the bonds and treasuries market. Literally, the word “trading” means “an exchange of goods and services with money or money’s worth.” In terms of financial markets, trading indicates an act of buying and selling of financial assets/securities in order to make profits over a certain period of time. There are various kinds of trading practices that investors follow while carrying out a financial transaction. Three types of trading stand out as the main trading systems, and various trading strategies are associated with each of them.
The three major types of trading are
- Day Trading
- Swing Trading
- Position Trading
While day trading and swing trading are short-term in nature, positional trading is of longer-term duration. Each of them serves a different purpose and suits different investor types.
1. Day trading
Day trading is a type of trading wherein traders buy or sell currencies for a single day in the hope of making desired profits. Day traders always close their trades within the same day, which minimizes risks associated with overnight movements in the market. By the end of the day, they exit with whatever profits or losses they have. The main objective of a day trader is to earn quick benefits from small price movements on an intra-day basis. There are four types of trading strategies that a day trader practices.
Scalping: Scalpers are concerned with only small changes in quotes. They put large orders at a certain level and after a small gain, let’s say 10 to 20 pips, they immediately reverse the position and exit. Scalpers believe that small moves in quotes are easier to capture than large ones. They also believe that by taking advantage of small moves in large positions, they can multiply profits.
Fading: Fading is a risky trading strategy wherein an investor trades against the prevailing market direction. The investor buys in times of declining prices and sells when the prices are increasing. The underlying psychology of a fade-trader is to take advantage of any price reversal because after a sharp decline or rise in the currency, it is bound to have show some reversals. This type of trading is extremely risky but is advantageous as well. It offers handsome amounts of return when it works. Fade-traders are often considered greedy, but generally they are simply risk takers. They follow strict risk management rules which offer specified fixed risks.
Daily Pivot: This type of trading strategy is based on a statistical tool called the pivot table. This table determines the pivot point, supports and resistances for the current movement. A trader then identifies the market movement and trades accordingly. The following are formulas which calculate pivot points:
Pivot Point for Current Price Level = High + Low + Close (previous)
Resistance 1 = (2 x Pivot Point) – Low (previous period)
Support 1 = (2 x Pivot Point) – High (previous period)
Resistance 2 = (Pivot Point – Support 1) + Resistance 1
Support 2 = Pivot Point – (Resistance 1 – Support 1)
Resistance 3 = (Pivot Point – Support 2) + Resistance 2
Support 3 = Pivot Point – (Resistance 2 – Support 2)
Pivot traders need to strictly use risk management tools to be successful. For example, if a trader generates a buy position at the current price, he/she uses the closest support as the stop-loss, while the target price is determined by the closest resistance. Pivot traders are dependent on statistical calculations and work more like machines than following a rationale behind the movement. In volatile markets, there is a higher chance of the stop-loss being triggered, which is why this strategy is more suitable for less volatile markets.
Momentum trading: The last type of trading strategy for day trading is one which rides on the ongoing movement in the market. Traders take a buy position when a currency is rising and sell when it is declining. They identify currency pairs which are moving significantly in one direction and trade accordingly. They use various momentum indicators, like the momentum oscillator, RSI, MACD, etc. in order to identify the strength of the current movement and decide whether to take positions and in which direction.
2. Swing Trading:
Like day trading, swing trading is another type of short-term trading. The basic difference between swing trading and day trading is the time frame: While day trading is limited to a single day, swing trading often stretches over more than one day in order to take advantage of quote swings. Similar to day trading, investors don’t hold positions long-term and don’t calculate in a long-term scenario. The time frame for swing trading may be an hour, a day or maximum a couple of days. Swing traders generally target higher profits than day traders. At the same time risks – especially those associated with holding positions overnight – are higher. Generally, three different swing trading strategies are distinguished.
Breakout trading: Breakout trading takes advantage of breakouts on charts. The breakouts can be small, like the high on an intraday chart, or they may be huge breakouts on daily, weekly and monthly charts. A breakout trader looks at the breakout point, asses if and when a currency quote witnesses those breakouts, and then takes their position and put the target close to next support or resistance level. They also maintain strict stop-loss points close to the breakout point which reduces their risk in times of adverse price movements.
Retracement trading: Another trading strategy for swing traders is retracement trading. The underlying technical indicator used for retracement trading is the Fibonacci Retracement. It is a mathematical calculation showing the retracement levels based on the Fibonacci ratios of 0%, 23.6%, 38.2%, 50%, 61.8%, and 100%. Fibonacci retracements are horizontal lines which indicate supports or resistances of the current trend. They are calculated by first locating turning points in the given chart: One needs to find the highest level and the lowest level of the quote during the specified time period. Then a line is drawn from the high to the low or the other way round. Six lines are drawn at different Fibonacci levels: 100% indicates the start of the move while 0% indicates the reversing point. 23.6%, 38.2%, 50% and 61.8% indicate the various support or resistance levels. The basic idea behind retracement trading is that when a price rises to a certain level and starts correcting, chances are high that it will test the previous levels.
Reversal trading: Reversal trading works when the market moves within a certain range. For example, if a currency quote starts facing selling pressure after testing highs, the quote is expected to test the lower levels again. Trader takes short position while the currency pair reverses from the high levels with the high being the stop-loss point. They take sell positions when the currency pair starts reversing from the lowest level in a range with the stop-loss being the low of the range.
3. Positional Trading:
The last type of trading practice is positional trading. Positional traders look for benefits from price movements over a comparatively longer time than swing or day traders. They generally hold their positions from days to weeks and sometimes for months as well. One of the keys to positional trading is to identify currency pairs which promise large movements. Positional trading always depends upon a mixture of fundamental and technical analysis. Positional traders always look for the longer-term effect of fundamental factors and then use technical analysis to decide the entry and exit points for the currency pair. In comparison to the other two types, positional traders expect a higher profit, while at the same time different risks are associated with the longer holding period.
This list of trading types and associated strategies is not exhaustive. However, the three most common trading practices – day trading, swing trading and positional trading – offer many opportunities for both beginners and experienced traders. Pivot trading – which mostly requires statistical formula that are generally built-in in many trading platforms – and retracement trading are some of the simpler strategies that are suitable for beginners. Reversal trading, breakout trading, scalping and fading, on the other hand, require a lot more skill and increased efforts from traders and therefore are generally practiced by more experienced market players. Positional trading is a blend of fundamental and technical analysis which takes traders a long time to practice and perfect. Not only level of experience and planned effort, but also the planning horizon should play a role in picking the right trading strategy: Positional trading are suitable for long-term investment strategies, while day trading and swing trading suit short-term investors better.
Created by Admiralmarkets.com.au, A Forex trading broker from Australia