The Importance of Knowing Your Trading Style
When a novice trader first enters the marketplace, he or she is bombarded with decisions regarding where to begin and what approach to take when it comes to trading and/or investing. There are as many styles of successful trading as there are traders, and which direction a trader takes is a very personal decision. There are four major factors one must consider in making this decision:
Which type of market analysis will I employ?
Which markets should I focus on?
Which strategies should I use for trading?
Which time frame should be my primary focus?
How a trader answers each of these questions will depend upon many factors, including, but not limited to, overall market expertise and knowledge, patience, emotional reactions to price movement, and the amount of time they can devote to the markets.
Which type of market analysis will I employ?
This question has two possibilities: fundamental analysis and technical analysis.
Fundamental analysis is based upon the belief that markets “misprice†a security in the short term, but that the “correct†price will eventually be obtained. This type of analysis is most commonly employed by long-term traders and investors using company data such as earnings and growth to provide a directional bias for a security’s upcoming price movement.
Technical analysis, on the other hand, is rooted in the premise that the price of a security already reflects all relevant factors such as earnings and cash flow. While many fundamental analysts use technical analysis to a certain extent, a pure technical analyst does not care at all about the fundamentals of a security. Instead, they look at price action within the security to guide them in predicting the security’s next move.
I am a pure technical analyst. Even though I know many fundamentalists who do quite well from an investment perspective, all of my own investment decisions are rooted in the analysis of the security’s price activity.
Which markets or securities should I focus on?
In this day and age, the current market which is all the rage is the foreign exchange market (most commonly known as the Forex or FX market). This is the largest and most liquid market in the world and the one where currencies are traded.
An inherent danger involved in Forex trading is the amount of leverage many traders use. This means that they are often taking positions much larger than the cash value of their account. The risk of loss is thus greatly increased as well. The FX market is a 24-hour market, however, and is thus very popular since it can be traded by those who already have a full-time job outside the market.
Another popular market is the options market. An option is a rather versatile security which can be used in a number of ways, such as speculating or hedging risk against an asset. For most traders, this is the most difficult type of security to learn to trade successfully and tends to have a longer learning curve than when compared with the others.
A fourth popular market is the commodities market. This is also known as the futures market.
The most popular futures are the E-Mini index futures. These include, but are not limited to, the mini-sized Dow Jones Industrial Average (the YM), the E-Mini S&P 500 (the ES), the E-Mini Nasdaq 100 (the NQ), and the E-Mini Russell 2000 (the ER).
This market is popular for many of the same reasons as the Forex market. It is also nearly a 24-hour market and offers large leverage without the requirement of a large cash account.
Then there is the straight stock market. This market involves the purchase of the absolute shares in a company. In order to open and close numerous positions within one trading day in the stock market, you must maintain an account of at least $25,000.
Which strategies should I employ for trading?
This question deals with style and the tools a trader uses when analyzing a potential trade. Many traders will use indicators such as moving averages, Fibonacci levels, stochastics, etc. to help provide them with a directional bias in terms of a security’s price.
The rule of thumb that I recommend is to not stray too far from the mainstream and not to become too overloaded with numerous indicators.
Many indicators, such as moving averages, have a bit of self-fulfillment to them and can be quite useful to a novice. Traders expect the moving averages levels have an impact on prices and hence make trading decisions based upon them. Of course, this is only part of the picture, but still food for thought.
The main problem with indicators is that many traders will ignore underlying price activity and when the indicators are giving contradictory signals it creates confusion. Many indicators will also tend to lag price movement and hence by the time a trader initiates a position based upon an indicator, they have already sacrificed a large portion of a security’s price movement and potential gain.
In addition to indicators, a trader’s strategy will also involve decisions such as which charting methodology to use. The most popular are line charts, bar charts, point and figure chart, and candlestick charts.
Next, a trader must decide which signals to use on the charts themselves in addition to any indicators. A popular strategy is to trade breakouts from a trading range. Another is to focus on trend-following methods such as buying pullbacks in a security which is moving higher.
Most trading systems and strategies are not this simple, however, and must involve entry and stop techniques, as well as profit-taking techniques. It often takes a great deal of trial and error for a trader to begin to recognize which set of market conditions give them the most accurate readings and hence the best positions.
Nearly all the time I spend mentoring my clients is devoted to having them develop their own systems of trading which focus on honing in on their own personality traits and expertise as applied to the market. The decisions involved in this part of the process are often the most difficult and I would highly recommend keeping a detailed trading journal. Just don’t forget to include charts!
Which time frame should be my primary focus?
It is here that a trader is pressed with the question of just what to call themselves, but it is one that is more a matter of pure semantics and has less to do with their success or failure than the other decisions thus far. The question is merely rooted in which time frame the trader wishes to focus upon.
A trader that looks to get into and out of a move intraday just based upon an initial movement in terms of momentum is called a scalper. They may only hold things for several minutes at a time.
A trader who is in and out of most of their positions within a single day is labeled a daytrader.
A trader who holds a position for several days on average is called a swingtrader.
A trader who holds for several weeks to several months is often referred to as a core trader or a position trader.
A trader who looks to hold a position for several years is often not called a trader at all, but is instead termed an investor.
Each time frame can involve a somewhat different mentality in that the emotional and risk aspects of trading on the different time frames tend to affect people differently. Some people have a difficult time holding positions overnight and lose sleep worrying about what could happen. These traders are best cut out for intraday trading.
Others find that when they trade positions intraday they take their gains and losses too quickly and don’t let the positions play out. It may better suit them to back off to a larger time frame and check on open positions much less actively.
Most strategies and pattern-based setups, however, will work on any time frame, no matter which a trader wishes to focus upon. I trade my same system on all of the above time frames, but will employ some strategies more often on position trades in stocks than on daytrades in the E-Minis simply because of opportunity and timing factors.
A word of advice:
Don’t get too obsessed with fitting exactly into a trade category when you begin trading.
I began my career purely as a swingtrader, looking only at daily charts of stocks, but now I not only swingtrade, but hold longer term, scalp intraday, and daytrade. I also trade more markets than simply stocks these days as well, most notably the E-Mini futures. I found that while I certainly have a core style and system in place, I apply it to many markets and time frames and have a rather extensive arsenal to allow me to adapt to changing market conditions.
A person who aspires to be a neurologist doesn’t just take neurology classes, he goes to medical school and obtains a broad knowledge of the field before specializing. Not only does that specialty involve knowledge of other aspects of medicine besides the brain, but the student might find out rather quickly that he simply is not cut out for it and may ultimately end up in a completely different area of expertise!
Feel free to try out a number of different strategies and markets to begin with. Just be responsible about it and keep risk to a bare minimum until you find the best fit!
Toni Hansen is one of the most respected technical analysts and traders in the industry. Toni is a frequent lecturer at trading clubs and industry expos. She is also a popular market columnist and is a repeat contributor to SFO Magazine. She recently co-authored High Profits in High Heels from Marketplace Books and SFO’s Personal Investor Series book Online Trading. Toni’s trading strategy can be found at www.swingtrader.net.