| Trading Places and Styles |
GOALS - First and foremost are goals. The first set of questions regarding goals should center on risk and return. One cannot consider return without weighing risk. It is akin to counting your chicken before they are hatched. Risk and return are highly correlated. The higher the potential return, the higher the potential risk. At one end of the spectrum are fixed deposits and government bonds, which offer the lowest risk (so-called risk free rate) and a guaranteed return. For stocks, the highest potential returns (and risk) center around growth industries with stock prices that exhibit high volatility and high price multiples (PE, Price/Sales, Price/Hope). The lowest potential returns (and risk) come from stocks in mature industries with stock prices that exhibit relatively low volatility and low price multiples.
STYLE - After your goals have been established, it is time to develop or choose a style that is consistent with achieving those goals. The expected return and desired risk will affect your trading or investing style. If your goal is income and safety, buying or selling at extreme levels (overbought/oversold) is an unlikely style. If your goals center on quick profits, high returns and high risk, then bottom picking strategies and gap trading may be your style.
Styles range from aggressive day traders looking to scalp 1-4% point gains to investors looking to capitalize on long-term macro economic trends. In between, there are a whole host of possible combinations including swing traders, position traders, aggressive growth investors, value investors and contrarians. Swing traders might look for 1-5 day trades, position traders for 1-8 week trades and value investors for 1-2 year trades.
Not only will your style depend on your goals, but also on your level of commitment. Day traders are likely to pursue an aggressive style with high activity levels. The goals would be focused on quick trades, small profits and very tight stop-loss levels. Intraday charts would be used to provide timely entry and exit points. A high level of commitment, focus and energy would be required. On the other hand, position traders are likely to use daily end-of-day charts and pursue 1-8 week price movements. The goal would be focused on short to intermediate price movements and the level of commitment, while still substantial, would be less than a day trader. Make sure your level of commitment jibes with your trading style. The more the trading involved, the higher the level of commitment.
STRATEGY - Once the goals have been set and preferred style adopted, it is time to develop a strategy. This strategy would be based on your return / risk preferences, trading / investing style and commitment level. Because there are many potential trading and investing strategies. For example, if the goal is a 20-30% annual return then it would involve a correspondingly high level of risk. So, it would be prudent to only allot a small percentage (5-10%) of your portfolio to this strategy. The remaining portion would go towards a more conservative approach. Then to decide the style, even though you would like to follow the market throughout the day, due to time constraints you cannot, thus it would be advisable to pursue a position trading style and look for 1-8 week price movements based on end-of-day charts. Indicators will be limited to the price action (candlesticks) and chart patterns will carry the most influence.
Part of this style should involve a strict money management scheme that would limit losses by imposing a stop-loss immediately after a trade is initiated. An exit strategy must be in place before the trade is initiated. Should the trade become a winner, the exit strategy would be revised to lock in gains. For example, you can lay a limit that any scrip closing above 5% should be booked as profit and the same percentage can be used as a stop loss. Also fix a limit of your capital per individual trade, say 5% of your total trading capital.
A clever trading strategy is to go long stocks that are near support levels and short stocks near resistance levels. To maintain prudence, you ought to seek long positions in stocks with weekly (long-term) bull trends and short positions in stocks with weekly (long-term) bear trends. In addition, look for stocks that are starting to show positive (or negative) divergences in key momentum indicators as well as signs of accumulation (or distribution). Your indicator arsenal should consist of two momentum indicators and one volume indicator
Gap trading is a simple and disciplined approach to buying and shorting stocks. Essentially one finds stocks that have a price gap from the previous close and watches the first hour of trading to identify the trading range. Rising above that range signals a buy, and falling below it signals a short. A gap is a change in price levels between the close and open of two consecutive days. In order to successfully trade gapping stocks, one should use a disciplined set of entry and exit rules to signal trades and minimize risk. Additionally, gap trading strategies can be applied to weekly, end-of-day, or intraday gaps. It is important for longer-term investors to understand the mechanics of gaps, as the 'short' signals can be used as the exit signal to sell holdings.
Some of the well known trading techniques which is frequently used is John Murphy’s ten basic laws of technical trading. They start off with
Mapping the Trends-a study long-term charts.
Spot the Trend and Go With It-Determine the trend and follow it whether long-term, intermediate-term and short-term. Buy dips if the trend is up. Sell rallies if the trend is down. If you're trading the intermediate trend, use daily and weekly charts.
Find the Low and High of It-Find support and resistance levels. The best place to buy a market is near support levels. That support is usually a previous reaction low. The best place to sell a market is near resistance levels. Resistance is usually a previous peak.
Know How Far to Backtrack Measure percentage retracements. Market corrections up or down usually retrace a significant portion of the previous trend. You can measure the corrections in an existing trend in simple percentages. A fifty percent retracement of a prior trend is most common. During a pullback in an uptrend, therefore, initial buy points are in the 33-38% retracement area.
Draw the Line-Draw trend lines. The breaking of trend lines usually signals a change in trend.
Follow that Average-Follow moving averages. Moving averages provide objective buy and sell signals. A combination chart of two moving averages is the most popular way of finding trading signals. Signals are given when the shorter average line crosses the longer.
Learn the Turns-Track Oscillators which help identify overbought and oversold markets.
Know the Warning Signs-Trade MACD. The Moving Average Convergence Divergence (MACD) indicator combines a moving average crossover system with the overbought/oversold elements of an oscillator. A buy signal occurs when the faster line crosses above the slower and both lines are below zero. A sell signal takes place when the faster line crosses below the slower from above the zero line. Weekly signals take precedence over daily signals.
Trend or Not a Trend-The Average Directional Movement Index (ADX) line helps determine whether a market is in a trending or a trading phase. And finally Know the Confirming Signs-Include volume and open interest. Volume and open interest are important confirming indicators in futures markets. Volume precedes price.
What we have introduced to you is just the tip of the ice berg. In case you are truly interested in trading-there are a number of websites where you can build a mock portfolio and follow the intra day and daily charts. So read up, acquaint yourself, practice, practice, practice and then arm yourself for the kill.
Aru Srivastava
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