When trading in financial markets, you will encounter several popular trading strategies. Discover the main ones and the process of developing one.
A trading strategy is based on a series of analyses to determine whether to buy or sell a currency pair, stock, or cryptocurrency and set procedures to determine the entry and exit strategy as well as risk management. Trading strategies can be based on a set of signals derived from technical analysis charting tools or fundamental news-based events.
A trading strategy can be either manual or automated. For most traders, a trading strategy is usually made up of technical signals that create a buy or sell decision when they point in a direction that has historically led to a profitable trade. The system is a trading plan that outlines what a trader should do when the signal is identified and a trading journal that captures what was done and why for future analysis and refinement of the system. This is a manual trading strategy that anyone can engage in. Running a manual trading strategy involves sitting at the computer screen, looking for signals, and interpreting your trading plan to decide what to do.
In an automated trading strategy, the trader teaches the software what signals to look for and how to interpret them. It is thought that automated trading removes the emotional and psychological components of trading that often lead to bad judgment. Automated strategies based on trading robots or expert advisors, tend to reduce human error and reduce reaction time when certain levels are breached. More complex automated trading strategies also come with common strategies and signals loaded in so the trader can combine several approaches in their system with relative ease.
What is the difference between trading strategy and trading style?
Although there is a lot of confusion between ‘style’ and ‘strategy’, there are some significant differences that every trader should know. While a trading style is an overarching plan for how often you’ll trade, and how long you’ll keep positions open, a strategy is a very specific methodology for defining at which price points you’ll enter and exit trades.
A trading style is your preferences while trading the market or instrument, such as how frequently and how long or short-term to trade. A trading style can change based on how the market behaves but this is dependent on whether you want to adapt or withdraw your trade until the conditions are favorable.
How to use the guide to Trading Strategies?
- Discover your trading style
- Explore the most popular trading strategies
- Learn how to develop a trading strategy in 5 steps
- Open a trading account to get access to our award-winning platform.
- Test out the various strategies you have learned to find which ones might be suitable for your trading style.
There’s no one-size-fits-all approach when it comes to trading, and no one person’s strategy will be the same. The strategy that’s going to work best for you will depend on your appetite for risk, your trading style, your level of motivation, and more.
Always do as much research as you can before entering the live markets and get your demo account to hone your skills.
The most popular Trading Styles
Although your trading style will be unique to you and the aims set out in your trading plan, there are four popular styles you can choose from. In order of duration, these are:
- Position Trading
- Swing Trading
- Day Trading
Timeframe: long term (weekly and monthly)
Holding period: month to years
Position trading means taking a longer-term position to ride a trend: Trading a longer-term trend (multiple days, weeks, or months) typically involves entering on a pullback to strong support, waiting to see if that support holds, and then going long soon after the longer-term trend bounces back up from support and resumes. This style is associated with longer-term trends (so pay attention to the relevant long-term fundamentals).
Investing is the most recognized form of position trading. However, an investor would deploy a ‘buy and hold’ strategy, whereas position trading can refer to short positions – to sell an asset – as well, through CFDs (contracts for difference).
Benefits of position trading
- High profits. Position trading allows traders to use high leverage, as the possibility of a mistake is smaller than in conventional trading.
- Less stress. One of the biggest advantages of position trading is that positions don't have to be checked daily.
Drawbacks of position trading
- Significant loss. Position traders tend to ignore minor fluctuations that can become full trend reversals and result in significant losses.
- Swap. The swap is a commission paid to the broker. If the position is open for an extended period, the swaps can accumulate a large amount
Timeframe: short to medium term (daily and weekly)
Holding period: days to weeks
The term ‘swing trading’ refers to trading both sides on the movements of any financial market. Swing trading involves entering just after a trend reverses briefly, then resumes. You enter just as price is pushing or “swinging” past its former resistance, which indicates that the trend has found new strength. Successful swing trading relies on the interpretation of the length and duration of each swing, as these define important support and resistance levels.
S&P 500 Daily Chart (Source: CAPEX WebTrader)
Benefits of swing trading
- It’s viable as a hobby. Swing trading can be more suitable for people with limited time in comparison to other trading strategies. However, it does require some research to understand how oscillation patterns work.
- Many trade opportunities. Swing trading involves trading ‘both sides’ of the market, so traders can go long and short across a number of assets.
Drawbacks of swing trading
- Overnight risk. Some trades will be held overnight, incurring additional risks, but this can be mitigated by placing a stop-loss order on your positions.
- It requires ample research. A lot of research is required to understand how to analyze markets, as technical analysis is comprised of a wide variety of technical indicators and patterns.
Timeframe: short term (5 minutes to daily)
Holding period: intraday (minutes to hours)
Day trading or intraday trading is suitable for traders that would like to actively trade in the daytime, as a full-time profession. Day traders take advantage of price fluctuations in-between the market open and close hours. Day traders often hold multiple positions open in a day, but do not leave positions open overnight to minimize the risk of overnight market volatility. It’s recommended that day traders follow an organized trading plan that can quickly adapt to fast market movements.
Benefits of day trading
- There is no overnight risk. Intra-day trading requires no trade is left open overnight.
- Limited intra-day risk. A day trader only opens short-term trades that usually last around 1 to 4 hours, which minimizes the likelihood of risks that may exist in longer-term trades.
- Time flexible trading. Day trading might suit people who desire flexibility with their trading. A day trader might enter 1 to 5 positions during the day and close all of them when objectives are hit or when they are stopped out.
- Multiple trade opportunities. A day trader can make use of local and international markets and can open and close many positions within the day, including taking advantage of 24/7 forex market hours.
Drawbacks of day trading
- It requires discipline. Like other short-term styles, intra-day trading requires discipline. Traders should utilize a pre-determined strategy, complete with entry, and exit levels, to manage their risk.
- Flat trades. This is when some positions do not move within the day, which is to be expected.
- More fees. More frequent trading means higher trading costs in the form of commissions and spreads. Paying all those extra charges may cut into your equity significantly.
Timeframe: very short term (1 minute to 1 hour)
Holding period: seconds to minutes
Scalping techniques involves trading based on a set of real-time analysis. The purpose of scalping is to ‘scalp’ a small profit from each trade in the hope that all the small profits accumulate.
Benefits of scalping
- There is no overnight risk. Scalpers do not hold overnight positions and most trades only last for a few minutes at maximum.
- It’s suitable as a hobby. Scalping is suitable for people who want to trade flexibly.
- Many trading opportunities. Scalpers open several small positions with a less defined criterion in comparison to other strategies, therefore there are a lot of opportunities to trade on.
Drawbacks of scalping
- Limited market applicability. Scalping only works in highly liquid markets. Scalping requires extremely high volatility and trading volumes to be worthwhile.
- Requires discipline. As scalping requires larger position sizes than other trading styles, traders need to be extremely disciplined.
- It’s an extremely tense environment. Monitoring the slightest price movements in search of profits can be an extremely intense activity. It’s therefore not recommended for beginner traders.
The most popular Trading Strategies
While any good trader should be using most of the techniques we cover within this trading strategy guide, there are different types or styles of trading for any given time frame. Here’s a brief listing of the most popular styles. The idea is just to acquaint you with these terms. There are whole forex books and trading courses written about each of these trading strategies, so use this listing as both an introduction to the vocabulary of trading techniques and as a starting point for further research into the styles that interest you. Just take these as general labels because trades often combine elements of more than one style.
The most popular trading strategies:
- Trend Trading
- Range Trading
- Breakout Trading
- Reversal Trading
- Momentum Trading
- News Trading
- Arbitrage Trading
Trend Trading Strategy
Trend trading is considered a medium-term strategy, best suited to position traders or swing traders, and is thus mostly based on technical analysis of trend strength. The goal is usually to enter after support and to ride the trend as it resumes. Also, when shorting to ride a downtrend, a pullback means a brief move up to a near-term high that serves as support.
Trend traders do not have a fixed view of where the market should go or in which direction. Success in trend trading can be defined by having an accurate system to first determine and then follow trends. However, it’s crucial to stay alert and adaptable as the trend can quickly change. Trend traders need to be aware of the risks of market reversals, those which can be mitigated with a trailing stop-loss order.
Range Trading Strategy
Range trading is a strategy that seeks to take advantage of an asset that is locked in a sideways trading range or channel, and you attempt to go long at the lows and short at the highs. This kind of trading works when you have both flat or weak trends, and wide channels that remain within lines of support and resistance. Range trading is popular among scalpers, as it focuses on short-term profit-taking, however, it can be seen across all timeframes and styles.
While trend traders focus on the overall trend, range traders will focus on the short-term oscillations in price.
It is a popular forex trading strategy, as many traders work off the idea that currencies remain in a tight trading range, with significant volatility in between these levels.
Breakout Trading Strategy
The breakout trading strategy is used by the active trader to take a position within a trend's initial stages. This strategy can be the starting point for major price moves, expansions in volatility and, when managed properly, can offer limited downside risk.
Breakouts occur in all types of market environments. Typically, the most explosive price movements are a result of channel breakouts and price pattern breakouts such as triangles, flags, double tops and bottoms, or head and shoulders patterns.
Breakout trading is commonly used by day traders and swing traders, as it takes advantage of short to medium-term market movements.
Reversal Trading Strategy
The reversal trading strategy is based on identifying when a current trend is going to change direction. Once the reversal has happened, the strategy will take on a lot of the characteristics of a trend trading strategy – as it can last for varying amounts of time.
A reversal can occur in both directions, as it is simply a turning point in market sentiment.
Reversals often occur in intraday trading and happen quickly, but they also occur over days, weeks, and years. Reversals occur on different time frames which are relevant to different traders. An intraday reversal on a five-minute chart does not matter to a long-term investor who is watching for a reversal on daily or weekly charts. Yet, the five-minute reversal is particularly important to a day trader.
Momentum Trading Strategy
Momentum trading is the practice of buying and selling assets according to the recent strength of price trends. It is based on the idea that if there is enough force behind a price move, it will continue to move in the same direction. The goal is to work with volatility by finding long opportunities in short-term uptrends and exiting when the price starts to lose momentum.
Momentum trading is based on the following key factors: volatility, volume, and time frame.
Momentum traders focus on price action rather than long-term growth and fundamentals, using technical indicators like momentum indicator, the RSI, moving averages, and the stochastic oscillator.
News Trading Strategy
The only day traders with an interest in fundamentals are news traders, those who base trades from major news announcements. Like any other type of trading, news trading it’s mostly based on technical analysis and methodologies, with today’s economic indicators serving as the catalyst.
News traders need to understand how certain announcements will affect their positions and the wider financial market. It is common that news is already factored into the assets price. This results from traders attempting to predict the results of future news announcements and in turn, the market’s response.
Additionally, they need to be able to understand news from a market perspective and not only subjectively.
Arbitrage Trading Strategy
Arbitrage in trading is the act of exploiting pricing differences or inefficiencies within the financial markets, such as forex, commodities, and shares, with the aim of making a profit.
Arbitrage is a useful process for traders because being able to profit from mispricing can help to drive the asset’s price and overall market back to equilibrium. It is a short-term trading strategy that can provide low-risk investment; however, as with all strategies, there are always some risks to consider.
Developing a Trading Strategy in 5 Steps
There is an old expression in the online trading business, if you fail to plan, you plan to fail. It may sound glib, but people that are serious about being successful, including traders, should follow those words as if they are written in stone. Ask any trader who makes money on a consistent basis, and they will tell you that you have two choices: 1) methodically follow a written plan or 2) fail.
If you already have a written trading strategy, congratulations, you are in the minority. It takes time, effort, and research to develop an approach or methodology that works in financial markets. While there are never any guarantees of success, you have eliminated one major roadblock by creating a detailed trading strategy or plan.
If your trading strategy uses flawed techniques or lacks preparation, your success won't come immediately, but at least you are able to chart and modify your course. By documenting the process, you learn what works and how to avoid the costly mistakes that newbie traders sometimes face. Whether or not you have a plan now, here are some ideas to help with the process of developing a suitable trading strategy.
Step 1 - Begin Your Search On Longer Time Frame Charts, Then Zoom In
Here’s the basic idea behind how we locate low-risk, high-potential trades. Start your search for low-risk trades by scanning charts with time frames that are 4 to 5 times longer than the time frame from which you intend to trade. The first goal is to find low-risk entry points by identifying the long-established, and therefore most reliable, support and resistance areas because they’re where the risk of opening a position is lowest. Here’s why.
If price breaches long-term strong support, that’s a clear signal that price is moving decisively against you. By entering long close to strong support, you can also set your stop-loss order (this tool will work under normal market conditions) close to that support, so that you escape with only a small, affordable loss, ideally, one that is ever less than your maximum allowed a loss of 1 to 3 percent of your trading account.
Or vice versa (entry near resistance, exit near support) if you are using CFDs to benefit from falling prices and market downturns.
Like a bird of prey, you begin your hunt where you can view lots of territories. The longer time frame allows you to view key support and resistance points over months or years. Then, if you see something interesting (a pair approaching one of those levels) you swoop in for a closer look at the shorter, time frame chart from which you trade, to make your final trading decisions. That’s where you’ll see if you’ve got a situation that combines a low-risk entry near strong support, with a resistance area far enough away from your entry point so that you have a good chance of earning three times as much as what you’ll lose if your stop-loss is hit, for a 3:1 reward/risk ratio.
Step 2 - Consider the Fundamental Context
Note that the longer you think the trade will need to play out, the more important it is that the trade fits with your fundamental analysis for your planned holding period. This is less important if you think the trade will last less than a week or so unless you’re trading based on a specific news item that’s due out during that time. However, trades that may take weeks or months are typically based at least in part on some theory you have about how certain fundamentals have been likely to play out.
For example, you go long the AUD/JPY because you believe markets will be optimistic over the coming weeks or months (favoring risk over safety currencies), or you believe Australia’s economic data will be much better than Japan’s.
Step 3 - Initial Screening on Longer Time Frame Charts
The purpose of your first screening is to find a trade setup that meets the following four criteria:
Risk Management Criterion #1: The currency pair, stock, crypto, or any other initially selected asset is approaching a strong support area that provides a low-risk entry point. For example, by definition, strong support/resistance levels on a weekly chart will be even stronger on a daily chart, because they’re more established than the support/resistance levels you see on daily charts. You then set your stop loss just far enough beyond this area so that it does not get hit by random price movements, but only when the price has turned far enough against you that you know you were wrong about the trade and it’s best to escape with a small loss. Thus, the stronger the support/resistance area where you enter, the lower your risk of a losing trade (barring any unforeseen change in fundamentals and sentiment). Once you know your entry and stop-loss points, you can check if the trade may meet your second criteria
Risk Management Criterion #2: Find the nearest major resistance area, because that’s where you’d expect to exit and take profits. If the distance from entry (at support) to exit (at resistance) is 2 to 3 times farther than the distance from entry to stop loss, then you may have a 2:1 to 3:1 reward/risk ratio. We’ll know for sure only when we do the second screening.
Risk Management Criterion #3: The stop loss should be far enough away from your entry point so that it does not get hit by normal random price movements, but only by larger moves against you that suggest price may be making a sustained move against you.
Money Management Criterion #1: The stop loss should be close enough to your entry point so that you don’t lose more than 1-3 percent of your account on the trade.
Again, we scan for situations that look like they might fulfill the preceding criteria on charts with a time frame four to five times longer than the time frame on which we trade. If we trade on daily charts, we scan weekly charts in the first screening.
This first screening doesn’t take long because we prefer to trade only the most liquid markets. There are only about eight liquid pairs, and about 20 liquid enough for most of your forex trading strategy. Similarly, a cryptocurrency trading strategy will follow the few popular ones (see here the best Cryptocurrencies to invest in for 2022) and avoid new cryptocurrencies without enough chart history and liquidity. On the other hand, a stock trading strategy will require more time and effort for screening through the best stock to invest in today.
In short, we’re scanning the long-term charts of these assets for an entry near strong support, with any likely resistance far enough away so that there’s a chance of getting a 1:3 or 1:2 risk-to-reward ratio.
As we’ll see, the deciding factor in whether you take the trade is if the second screening on the daily charts shows you can get a combination of stop-loss, entry, and exit points that allow the desired risk-to-reward ratio yet does not cost you more than 1 to 3 percent of your account if the stop loss is hit.
For the purpose of illustration, assume just one entry and exit, and mostly avoid consideration of variations like trailing stop losses and partial or staged entries and exits.
When we talk about strong support or resistance, that means we want to see at least one well-tested kind of support, ideally as many kinds as we can get, all converging on a narrow price range. Just to remind you, these include:
- Prices that have clearly been support or resistance in the past; often these are round numbers because traders tend to think in round numbers.
- Trend lines and/or their variations like channels, moving averages, Ichimoku Kinko Hyo, and Bollinger Bands.
- Fibonacci retracement and Elliot Waves
- Chart patterns, besides being useful, also provide additional evidence of support/resistance points.
- Technical indicators for overbought/oversold and divergence signals like RSI (Relative Strength Index), MACD (Moving Average Convergence Divergence), or Stochastic Oscillator.
Step 4 - Second Screening
Once you’ve found some situations that meet these criteria on the weekly charts, the next step is to see if the same criteria for low-risk, high potential reward trades are present in your chosen time frame, in this case, daily charts.
Why bother with the first screening? As noted previously, the longer time frame chart shows you stronger support/resistance levels. We are hoping to find an entry point on the daily charts that is near the stronger support/resistance areas found on the longer time frame, in this case, the weekly charts. If we find that a pair nears its weekly support/resistance, we’ll know it’s worth doing a second screening on the daily chart.
Again, the deciding factor in whether you take the trade will be if the daily chart (or whatever time frame from which you trade) shows the combination of stop-loss, entry, and exit points that allow the desired risk-to-reward ratio yet will not cost you more than 1 to 3 percent of your account if the stop loss is hit. To reiterate:
- The stop loss is far enough past strong support so that it would get hit only by strong price moves that signal your trade idea was mistaken and close enough so you’re out with a small but affordable loss that doesn’t exceed 1 to 3 percent of your trading capital, so you can afford lots of mistakes, have space to recover your losses, and possibly be profitable
- It’s two to three times closer to your entry point than is your profit-taking point, so you have a 1:3 or at worst 1:2 risk-to-reward ratio.
Regarding stop loss placement, remember that there are different methods. These include:
- The Intuitive Approach: Study the chart for the relevant period and define the market range for the normal up and down oscillation of price. You want your stop loss to be no closer to your entry point than that distance, ideally, a bit more than that, while still not causing a loss greater than your 1–3 percent limit. This is a quite simple approach and hence the one we choose to use in the example that follows. This method involves a heavy dose of personal judgment.
- The Somewhat More Objective Approach: Set distance from the entry point to stop loss based on fixed percentages (also a judgment call) of the Average True Range (ATR), or other formula or statistically based methods to ensure you don’t get shaken out of your trade due to normal price fluctuations.
Regarding the risk-to-reward ratio, if the trade is in the direction of a strong trend, it is safer to be more aggressive, so we are more likely to accept a 1:2 risk-to-reward ratio.
In the end, you’re always trying to strike a balance between the size of the loss if hit versus the risk of being stopped out. In other words, the farther away your stop-loss is from your entry point, the bigger the loss if hit but the lower the chance of being hit by random price fluctuations rather than a real move against you.
If the second screening shows that you can get the desired risk-to-reward ratio without risking more than 1 to 3 percent of your capital, you take the trade near strong support. The precise entry level you choose is a judgment call. You’re trying to strike a balance between entering at the best price and not being so greedy that price never hits your order, and you miss the trade altogether.
Step 5 - Third Screening to Monitor Trade Progress
This screening occurs on a chart time frame four to five times shorter than your trading time frame. For example, if you’re trading on daily charts, then use one- to four-hour candlestick charts. This one usually doesn’t determine whether you take the trade. Instead, it’s mostly just to identify short-term support/resistance points that are likely to be temporary, so you’re not surprised if the trend halts or reverses around these zones. Rather than getting worried, you expect a progressing trade to temporarily halt or even reverse. These areas can also serve as points where you augment or reduce your position if you’re using staged entries and exits.
At times, this screening may alter your trading strategy. For example, if the price repeatedly struggles to break through the resistance you see on the four-hour chart, that might indicate that the longer-term trend may be failing, especially if important new information just came out. Similarly, if there’s too much quality short-term resistance too close to your entry, you might elect to enter in stages, saving most of your planned position until the price clears that resistance area. Alternatively, if there are better opportunities or if breaking newscasts doubts on your conclusions from the second screening, you might change your mind about the trade and just get out.
In sum, what is the best trading strategy?
When it comes to trading strategies, they can all perform well under specific market conditions; the best trading strategy is a subjective matter. However, it’s recommended to pick a trading strategy based on your personality type, level of discipline, available capital, risk tolerance, and availability.
You can learn more about each trading strategy with CAPEX Academy's online courses.
Putting your strategy in action can take time, dedication, and practice. You can start with a demo account, where you can put your strategy to the test in a risk-free environment. You’ll even get $50,000 in virtual funds to practice with when you sign up.
You can also use the demo account as an opportunity to explore the markets and get into the daily habits of a trader. Once you’re ready to take on the live markets, you’ll have access to a range of different trading platforms and trading apps. You can choose between our innovative web platform, our award-winning mobile app, or specialized platforms such as MT5. You’ll also have access to integrated tools, from analysis to market consensus and sentiment apps. Plus, Trading Central provides actionable trading setups.
Users/readers should not rely solely on the information presented herewith and should do their own research/analysis by also reading the actual underlying research. The content herewith is generic and does not take into consideration individual personal circumstances, investment experience or current financial situation.
Key Way Markets Ltd shall not accept any responsibility for any losses of traders due to the use and the content of the information presented herein. Past performance and forecasts are not reliable indicators of future results.