Important Types of Trading Strategies in 2024

Trading strategies refer to systematic plans that help you reap profits by placing and executing trades after accounting for multiple factors. They help you navigate market complexities and make informed investment decisions based on your financial objectives and risk tolerance.  

These strategies play a vital role in trading success because they:  

• Define the rules that drive rational buy and sell decisions, unaffected by emotions or impulses 
• Help define the risk of a trade and take steps to minimise losses and preserve capital 
• Ensure consistency in approach towards different kinds of trade execution 
• Help investors adapt to changing market conditions
• Help analyse market data objectively 
• Save the investor’s time by outlining predefined rules for trade execution 
• Are aligned with the investor’s financial goals and can be improved 

Before diving into the popular trading strategies, let’s understand the two main trading styles – active and passive. 

Trading Styles – Active vs Passive 

Active trading involves the purchase and sale of assets with the intent of earning quick profits based on short-term price movements. Passive trading involves a long timeframe where the goal is to reap maximum profits with minimal purchase and sale of assets. 

Active vs Passive Trading

Parameters	Active Trading	Passive Trading
Transaction frequency	Frequent buying and selling (even within a single day)	Long-term investment horizon and fewer transactions
Decision-making	Based on price movements in the short term, market trends, technical analysis, news etc.	Buy-and-hold strategy based on index investing principles and overall market growth
Objective	Capitalise on short-term price and market fluctuations	Profit from wide market exposure and its overall growth
Time commitment	Significant commitment needed for constant data analysis and trade execution	Less commitment needed as it doesn’t involve frequent trading
Risk and return	Higher risk (due to price volatility) and high return potential (due to market fluctuations)	Lower risk and return potential
Cost	Brokerage fees and other trading expenses	Lower cost of transaction
Strategies	Swing trading, day trading, etc. (involves the usage of indicators, chart patterns)	Replicating a market index’s performance over the long term

 

You can opt for one of the above styles or a combination based on your risk appetite, financial objectives, and personal preferences. 

Now, let’s explore the popular trading strategies. 

Trend Following Strategies 

Trend-following strategies help you profit from the assumption that a security’s price movement is likely to persist in the same direction in which it is trending at present. When the overall direction of an asset’s price movement is upward, it is called an uptrend. When the overall direction is downwards, it is called a downtrend. 

Trend trading strategies can be of different kinds, each involving multiple indicators (mathematical calculations based on an asset’s historical data related to price, volume, etc.). Let’s explore some well-known indicators: 

Moving Averages

• A moving average indicator smooths out a stock’s price data over a specific period and mitigates the effect of short-term fluctuations. 
• While a simple moving average is an arithmetic average of all prices over a timespan, an exponential average assigns more weightage to recent prices vis-à-vis older ones. 
• Moving averages help identify a stock’s trend direction and its support (lowest price reached before trend reversal) and resistance (highest price reached before trend reversal) levels.  

Trend Lines

• A trend line graphically indicates the direction in which an investment’s value is moving by connecting significant price points (lows or highs). 
• The angle and slope of a trend line indicate the trend’s strength. A steep angle hints at a strong trend, while a shallow angle means there is a chance of the trend weakening or reversing. 
• A trend line can act as the support level in an uptrend and the resistance level in a downtrend. 
• The effectiveness of trend lines might decline gradually, so you might have to redraw them to account for changing market conditions. 

Technical Oscillators 

• These help in measuring and analysing the strength, momentum, and chance of reversals in price movements. 
• An oscillator uses two extreme values to form high and low bands in between. It then constructs a trend indicator that swings within these bands. 
• This trend indicator can be used to figure out if an asset is oversold or overbought in the short term. If the oscillator nears the upper extreme value, the asset is overbought. If it nears the lower extreme value, the asset is oversold. 
• Technical oscillators help detect the right points for entering or exiting a trade.  

Mean Reversion Strategies 

These strategies are backed by the theory that the price of an asset tends to revert to the historical average over a period. Here are the key characteristics traders take into account: 

• The main idea is that an asset stays in an oversold or overbought condition temporarily. 
• Before investing, traders look for scenarios where an asset’s price deviates from its historical mean significantly.  
• Traders often assume positions that oppose the existing trend. They sell when prices are way higher than the average or buy when prices are way below the mean. 
• You must manage risk properly in mean reversion strategies, as prices might keep deviating from the average longer than expected. To minimise losses, you might have to set stop-loss orders. 

Day Trading Strategies 

Such strategies involve the purchase and sale of financial assets during the same trading day. The objective is to earn profits from price movements in the short term or intraday volatility. Some widely-used day trading strategies are listed: 

• Trading in the same direction as the prevailing trend, like selling in a downtrend and buying in an uptrend. 
• Assuming positions that are opposed to the existing trend, expecting a correction. 
• Capitalising on quick price movements to reap frequent and small profits.  
• Profiting when the price oscillates within a certain range, either from buying near the support level or selling near the resistance level. 
• Entering trades when the price breaks out below the support level or above the resistance level. 
• Identifying reversals in a trend and trading in the new direction. 
• Identifying stocks that have high relative strength and trading in the direction of the existing momentum. 
• Capitalising on price volatility following a major news or event. 

Swing Trading Strategies 

In swing trading, investors aim to profit from short and medium-term movements (swings) in the price. Trading positions are held for more than a day to several weeks. Well-known swing trading strategies involve entering a trade: 

• When there are signs that a prevailing trend might reverse. 
• When a financial instrument’s price breaks below support or above resistance. 
• In the direction of the existing trend, expecting it to continue. 
• Near the support or resistance level, expecting the price to bounce. 
• After identifying areas where the price might retrace before continuing its trend. 
• When an asset’s price reaches an oversold or overbought condition in anticipation of a reversal. 
• When the divergence between momentum and price suggests a reversal.    

Position Trading Strategies 

Position trading involves buying a financial asset and holding it for an extended term, to benefit from a rise in value owing to fundamental factors. Let’s look at the popular position trading strategies: 

• Entering a long position (investor expects the security value to rise) in an uptrend or a short position (selling a security and hoping to repurchase it at a lower price) in a downtrend and holding it for a long time. 
• Buying and holding assets with strong fundamentals, expecting capital appreciation. 
• Assuming a long-term position based on the fundamentals of a company. 
• Taking short or long positions based on the expected effect of geopolitical events, global economic trends, and interest rates on different assets. 
• Rotating positions among sectors that are anticipated to outperform during a specific economic cycle. 
• Identifying promising positions by analysing global economic conditions first and then moving to individual sectors and assets. 
• Investing in currently undervalued assets with future growth potential. 
• Investing in income-generating assets to earn regular dividends and benefit from capital appreciation. 
• Entering positions in line with the prevailing trend and holding them for a long time. 

Trading Psychology and Risk Management 

Mastering the right psychology and managing risk efficiently are essential to succeed in trading. Here’s how to go about it: 

Trading Psychology

• Avoid making impulsive decisions. 
• Develop a resilient approach to look beyond short-term ups and downs. 
• Wait for the right opportunities and avoid premature exits or entries. 
• Tweak trading strategies when markets evolve. 
• Be wary of overconfidence, which can result in poor decision-making. 
• Stay aware of market developments and macroeconomic factors. 
• Learn your lessons from losses. 

Risk Management 

• Calculate every trade’s size as a percentage of your total trading capital. 
• Define the maximum loss acceptable on a trade with stop-loss orders. 
• Ensure the risk-reward ratio is favourable. 
• Minimise losses by spreading your capital across multiple trades or assets. 
• Craft a trading plan with rules for risk management and adhere to it. 
• Review the trading portfolio regularly and tweak if necessary. 

Backtesting and System Development 

Backtesting involves testing a trading strategy based on historical data to gauge its performance and viability in the real world. It helps assess the risks of the strategy as well as areas of improvement. System development, on the other hand, is about crafting and refining a trading strategy or system. 

Here’s how to go about these crucial aspects of successful trading: 

Backtesting 

• Define the parameters and rules of the trading strategy. 
• Pick a relevant timeframe for testing purposes. 
• Collect historical data on open, low, high, and close prices. 
• Simulate the strategy’s execution using historical data. 
• Consider metrics like profit, loss, win-loss ratio, etc., to assess the strategy’s performance. 

System Development 

• Define the trading system’s objectives, timeframes, market type, performance expectations, and risk tolerance. 
• Research market conditions, understand the factors impacting price movements, and consider multiple trading strategies. 
• Build a conceptual framework, define risk management parameters, and set exit and entry rules. 
• Use backtesting for initial testing and optimisation. Then, tweak rules and parameters to improve performance. 
• Track the system’s performance regularly in live markets and make adjustments when needed. 

Learn More 

In a nutshell, exploring various trading strategies, developing a disciplined approach, having a balanced and rational trading system, assessing and managing risk, and adapting to changes are crucial for trading successfully. 

The next module will explain how trade profits are taxed so you can estimate your returns accurately.