This article will show you some of the most common trading strategies and also how you can analyze the pros and cons of each one to decide the best one for your personal trading style.
The top five strategies that we will cover are as follows:
Breakouts are one of the most common techniques used in the market to trade. They consist of identifying a key price level and then buying or selling as the price breaks that pre determined level. The expectation is that if the price has enough force to break the level then it will continue to move in that direction.
The concept of a breakout is relatively simple and requires a moderate understanding of support and resistance.
When the market is trending and moving strongly in one direction, breakout trading ensures that you never miss the move.
Generally breakouts are used when the market is already at or near the extreme high / lows of the recent past. The expectation is that the price will continue moving with the trend and actually break the extreme high and continue. With this in mind, to effectively take the trade we simply need to place an order just above the high or just below the low so that the trade automatically gets entered when the price moves. These are called limit orders.
It is very important to avoid trading breakouts when the market is not trending because this will result in false trades that result in losses. The reason for these losses is that the market does not have the momentum to continue the move beyond the extreme highs and lows. When the price hits these areas, it usually then drops back down into the previous range, resulting in losses for any traders trying to hold in the direction of the move.
Retracements require a slightly different skill set and revolve around the trader identifying a clear direction for the price to move in and become confident that the price will continue moving in. This strategy is based on the fact that after each move in the expected direction, the price will temporarily reverse as traders take their profits and novice participants attempt to trade in the opposite direction. These pull backs or retracements actually offer professional traders with a much better price at which to enter in the original direction just before the continuation of the move.
When trading retracements support and resistance is also used, as with break outs. Fundamental analysis is also crucial to this type of trading.
When the initial move has taken place traders will be aware of the various price levels that have already been breached in the original move. They pay particular attention to key levels of Support and Resistance and areas on the price chart such as ‘00’ levels. These are the levels that they will look to buy or sell from later on.
Retracements are only used by traders during times when short term sentiment is altered by economic events and news. This news can cause temporary shocks to the market which result in these retracements against the direction of the original move.
The initial reasons for the move may still be in place but the short term event may cause investors to become nervous and take their profits, which in turn causes the retracement. Because the initial conditions remain this then offers other professional investors an opportunity to get back into the move at a better price, which they very often do.
Retracement trading is generally ineffective when there are no clear fundamental reasons for the move in the first place. Therefore if you see a large move but cannot identify a clear fundamental reason for this move the direction can change quickly and what seems to be a retracement can actually turn out to be a new move in the opposite direction. This will result in losses for anyone trying to trade in line with the original move.