When developing a trading strategy, many things must be considered for example: return, risk, volatility, time-frame, style, correlation with the markets, methods etc. After developing a strategy, it should be back-tested using computer programs (see RBTA). Although back-testing is no guarantee of future performance, it gives the trader confidence that the strategy has worked in the past. If the strategy is not over-optimized, data-mined, or based on random coincidences, it might have a good chance of working in the future.
Trading strategies can be based using different Styles and Time-frames as follows:
Styles:
| Quantitative trading | Quantitative trading strategies use both simple and complicated mathematical solutions for determining optimal investment strategies. Quantitative methods use a variety of mathematical tools to first filter the data to separate trending or non-trending periods, then to maximize the attempt to capture as much of the trend as possible. The ability to receive data in real time or download end-of-day data and manipulate it through modern computers has greatly added to the ability to convert price data into functional trading plans. Such mathematical solutions may use both fundamental techniques and/or technical studies. |
|---|---|
| Trend following | “Trend is your friend.” It simply means that you should trade with the trend of the market to increase your chances of success. The reasoning behind following the trend is that prices are more likely to continue in that same direction than reverse. A trend means that prices are steadily moving higher or lower over a period of time. Trend analysis can be done by Technical Analysis. Technical Analysis has many “studies” which can be applied to determine trend, entry/exit points, key reversal points etc. Mastering these techniques is an art and takes many years of experience. These studies can be used in various permutations and combinations. Unfortunately there is no precise recipe and one has to figure out what works for oneself by trial and error method. For example, one could use a combination of Moving Averages, Relative Strength Index or Moving Average Convergence Divergence for determining the trend and buy/sell points; whereas for the same situation another person could use Ichimoku and arrive at same or different strategy. Important to note here is that most experienced traders learn by analysing past data and applying various studies to determine which study has worked well (this is referred as Back-testing); only after establishing this validity these traders would use the studies for present conditions and make their judgements. |
| Mean reversion | Mean reversion trading examines the statistical relationship of the current price to its statistical trend. Reversion means that eventually, a current price will return to its historical mean. Reversion is measured by finding the number of standard deviations the current price is from the trend or midpoint. |
Time-frame: Trading strategies can be very short term (few minutes) to long term (few months and in some cases years as well). The time-frame would determine the risk/reward profile as well as your trading strategy.
| Scalping | It is one of the most popular strategies, and it involves selling almost immediately after a trade becomes profitable. Here the price target is obviously just after profitability is attained. |
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Other innovative methods can also be applied for trading, like:
| Fading | It involves shorting after rapid moves upwards. This is based on the assumption that (1) the market is overbought, (2) early buyers are ready to begin taking profits and (3) existing buyers may be scared out. Although risky, this strategy can be extremely rewarding. Here the price target is when buyers begin stepping in again. |
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| Gorilla Trading | Buying near the closing bell and selling the next morning or vice-versa (holding a position overnight). |
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