There are many different types of trading styles and techniques available to the market trader. You might consider yourself a short-term trader or a long-term trader, or possibly somewhere in between. But what does that really mean? These terms tend to be relative, and mean different things to different traders.
For example, short term for one trader could mean several minutes, while short term for another trader could mean several days. In this article, we want to clearly define the various trading styles and the characteristics of each.
Discretionary vs Automated Trading Approach
Before we dive into the different trading styles and strategies available to the market trader, we should first understand the method in which the trader will execute their trades.
When it comes to trading the markets, there are essentially two primary execution approaches that a trader can utilize. The first is a discretionary approach, wherein, the trader uses their judgement and discretion when executing and managing their trades.
The second is a system based or automated trading approach, wherein the trading system is responsible for initiating and managing the trade. In a system trading environment, the trader’s primary responsibility is in the initial setup and programming of the automated trading system and regular monitoring of the system to ensure that the system is functioning in a proper manner.
The choice of which execution approach you prefer will depend on your psychological makeup and comfort level. For example, if your personality is one where you prefer to be in control of trading related decisions, then a discretionary based approach may be more suitable for you.
If on the other hand, you are comfortable with letting a rule based trading algorithm execute trades in the market, then a System based approach may be something that would work for you.
All the trading styles that we will discuss in the upcoming sections can be either discretionary based or system based. Keep in mind that a discretionary trader can be systematic in that He or She follows a strict rule based strategy, but applies certain discretion in the process. But a system trader cannot be discretionary, and must follow all trades provided by their automated trading program, in order to truly qualify as a system trader.
It is important to ask yourself which type of trading approach you are more comfortable with, and then narrow in on the trading style that would best compliment that for you.
Trading Style #1 – Scalping
Scalping is a fast-paced trading style that can be highly intense and often times carries with it a good deal of stress. Scalping involves looking for a steady stream of opportunities in the market. Scalpers can often trade 20, 30, or in excess of 50 positions during a trading session. Most scalpers tend to be in and out of their position within minutes.
Scalpers are typically using a good deal of leverage and are looking for small minor moves that they can take advantage of with regular frequency. For example, a Scalper trading the EURUSD could trade a dozen or more positions on a smaller time frame such as the 1 minute or 2-minute chart based on a breakout on the daily chart.
Scalping is quite popular in the Equities markets, where these traders can utilize Level 2 data to route orders for the best pricing and fastest execution. But if you are interested in scalping the Equities market, you should be aware of the Pattern Day Trader rule in the United States, which requires a trading account of at least $25,000 to qualify for executing multiple round turns during the trading session.
As you might imagine, one of the biggest drawbacks of using a Scalping trading style is the high cost of transaction fees associated with the large turnover generated by these trading activities. Many times, the transaction costs in the form of commissions can eat into 60-70% or more of a trader’s gross profit. So, scalpers need to ensure that they are receiving the lowest commission rates possible from their broker and any exchanges in order to have a chance at succeeding with this approach.
These days Scalpers that are discretionary based have a lot of competition from High Frequency trading firms. HFT’s are the ultimate scalpers, and can typically take hundreds if not thousands of trades throughout the daily trading session. It’s no wonder that computer algos tend to dominate the scalping arena.
Trading Style #2 – Day Trading
Day Trading is somewhat similar to Scalping in that traders are looking to enter and exit their position during the same trading session. But a major distinction between the two is that Day traders tend to have a longer time horizon than most scalpers.
Day traders are usually not in and out of positions within minutes. They typically employ day trading techniques that look for larger swings during the day that they can capture. As such, a day trader can stay with a position for as little as 30 minutes to several hours or the entire trading session from open to close.
Most daytraders will put on about two to five positions per day depending on the volatility in the market. Although transaction costs can weigh on a daytrader’s bottom line, they are not nearly as pronounced are they are for Scalpers. And while a large majority of Scalpers tend to focus on automated trade execution models, many day traders are still discretionary in nature.
Aside from some day traders that focus on news trading, the majority of day traders are technically oriented. They are not as concerned with large macro-economic trends since their time horizon does not require projections beyond several days to a week.
To be an effective day trader, you should have the disciple to ensure that you are closing out all open positions by the end of the trading day. Some novice day-traders have a difficult time exiting losing trades at the end of the session because they still believe that prices will turn around. They let a short-term day trade turn into a swing trade or worse a longer-term position.
Every successful day trader knows that the markets will always be there and that they can always re-engage their position if they need to. But they realize that what is critical and essential for them as a day trader is to go home flat each day and start anew every morning. Their risk plan calls for being flat at the close and that’s exactly what disciplined daytraders do.
Trading Style #3 – Swing Trading
Swing trading involves trading with a time horizon of about a day to less than several weeks. Swing traders typically trade the 240 minute and 480 minute charts in the Forex Market, and the 60 minute and 120 minute charts in the Equites and Futures markets. Swing traders have the best of both worlds when it comes to frequency of trades, and the cost of trading.
As for frequency, swing traders have ample opportunities to trade the market, and it is typical for these traders to take 8-12 positions per month, which could translate to 100-150 trades per year. From this perspective, it is an excellent style of trading for beginning traders because of the large number of opportunities available for testing and honing their skills in the market.
The cost of trading in the form of dealing spreads and commissions is also greatly reduced with swing trading. The lower frequency of trading compared to day trading and scalping coupled with higher Pip targets makes swing trading one of the most attractive trading styles for professional speculators.
Another major advantage of swing trading techniques is that many technical patterns that form on these relatively higher timeframes are much more accurate and reliable. For example, a support level formed on the 240-min chart on the EURUSD is much more important than a support level formed on a 15-minute chart. And the same goes for chart patterns as well. A head and shoulder pattern forming on the 120-minute chart is far superior to the same pattern appearing on the 5-minute chart.
There are countless trading techniques in the market that can be employed with a Swing Trading style. You can be a mean reverting trader selling the tops and buying the bottoms of Bollinger Band extremes, or you can be a Momentum trader buying breakouts from S/R levels, or you can buy dips within an uptrend or sell rallies within a downtrend. Choosing the best trading technique will depend on your own personality and skill set.
Trading Style #4 – News Trading
News trading is a subset of fundamental analysis. News traders seek to capture a price move after a scheduled news announcement. Economic events such as US Non-Farm Payroll, Central Bank rate statements, Inflation reports such as PPI and CPI, and Quarterly GDP reports can produce increased volatility in the market.
Usually when the figures from the scheduled news announcement deviate materially from analysts’ consensus, then a sharp reaction can occur in the market. Sometimes prices can soar by 150 pips or more within seconds, and also conversely drop 150 pips or more within seconds.
News trading can be quite tricky and risky as these types of knee jerk reactions can sometimes occur on both the long and short side of the market, making it difficult to gauge the true direction the market is headed in. Strict money management rules and hard stop losses are a must for news traders due to the heightened risk during these times in the market.
There are various strategies and techniques that a news trader can use to take advantage of their trade ideas. They can buy or sell a currency pair outright in the forex market, make use of a leveraged futures position, or even construct a position using FX options.
Regardless of the technique used, it is important to note that just before these scheduled news events, the price of certain pairs that could be effected by the report, usually trade in a consolidation range, as traders are awaiting the news event. And as the important economic report draws nearer, the dealing spreads will tend to widen as market making forex brokers are looking to balance their books to protect themselves from potentially adverse price shocks as well.
Some news traders prefer an intraday trading technique wherein they initiate a trade immediately following the the news event. Other news traders prefer to wait for the market to cool down a bit and wait for a pullback before entering into the direction of the intraday trend created by the news event.
Trading Style #5 – Trend Trading
Trend Trading is a popular trading strategy among many Commodity Trading Advisors (CTAs) and Professional Hedge Funds. Trend Trading was originally popularized by world renown traders Bill Eckhardt and Richard Dennis through their “Turtles” Experiment.
If you’re not familiar with the Turtles story, it would be advisable for you to do some reading into this. But to explain briefly, these two men made a bet to see whether they could teach regular people from a diverse set of backgrounds their trend following methodology to see if these traders could be trained to succeed in the markets.
The results of the experiment showed that, in fact, traders could be trained to succeed and be profitable in the markets. Some of the original Turtles have gone on to become hugely successful private traders, and hedge fund managers.
The idea of trading with the trend appeals to many traders. We know from the law of physics that all things follow the path of least resistance. Most trend traders are longer term in nature. They tend to focus on the daily and weekly chart, looking for moving markets.
The primary goal of a trend trader is not to predict where the market might be going, but rather to join a market that is already showing signs of strong movement in a particular direction. Trend traders seek to jump on emerging and established trends and plan on staying in them for as long as the market continues to move in their desired direction.
A major difficulty that many newer traders have with trend following lyes in their ability to spot and get aboard a trending market before it’s too late. By the time most retail traders get into a trending market, most of the move is likely already exhausted. So, the trick is to be able to spot an emerging trend and get in as close to the beginning or middle of the trend as possible.
Trading Style #6 – Macro-Economic Trading
Macroeconomic traders are primarily focused on long term fundamental data that drives a country’s economy. These traders are long term in nature and can often hold onto a position for months if not years, and many only have a handful of positions open throughout the course of a year. These traders obviously like to pick their positions carefully as their limited bets can make or break their year.
Some of the most important economic data that macro-economic traders like to study include a country’s GDP relative to its peers, the current Inflation and Employment situation, the interest rate environment and trade balance data.
It is from this primary set of data that the Macro economic trader can begin to build a forecast for what they expect for a particular country, and its exchange rate with respect to other counties.
Successful macro-economic traders can spot emerging trends within the current business cycle and position themselves to get into a market before many others are aware of an impending change. These traders tend to be very aware of overall market sentiment and look for early shifts in sentiment and mass trader psychology to forecast the next likely path within the economic cycle.
Although macro-economic traders rely mainly on fundamental techniques for trade evaluation, they often use technical analysis to help them time their trades for optimal entry and exit.
An important analytical technique implemented by many macro-economic traders is the use of inter-market analysis. They routinely study the cause and effect relationships among various asset classes.
For example, macro-economic traders want to know:
How are government bonds moving in relation to stocks?
What effects are certain currencies are having on crude oil prices?
Where are commodity prices in relation to US Dollar?
What relationship if any exists between Gold and Equities?
These are just some of the questions that Macroeconomic traders try to answer before making an informed forecast.
Trading Style #7 – Carry Trading
Carry trades are used by many large institutions around the globe to try to earn significant interest income. Essentially with a currency carry trade, you are buying a higher interest yielding currency, and financing that with a lower interest yielding currency.
So, for example, if the Australian Dollar has a 4 percent interest rate and the Japanese Yen has a 1 percent interest rate, then buying the AUD/JPY pair would yield a net 3 percent interest rate, and it is considered a positive carry.
If on the other hand, you sold the AUD/JPY pair then you would pay a 3 percent interest rate instead. This is considered a negative carry trade. Directional traders should be aware of the carry trade effect when they are buying and selling currencies, because the negative carry cost can sometimes eat into the potential gains beyond their expected return.
You may be wondering why such a low interest rate would appeal to speculators or institutions utilizing the carry trade approach. Well the important thing to remember with this forex trading technique is that you earn or pay that interest on the notional value, so a leveraged position could likely earn many multiples of interest rate differential. For example, based on the 3% we mentioned earlier, a 10:1 leveraged position could potentially earn 30% yearly interest.
Now although a carry trade sounds like a no-lose proposition, in fact, you still have to take into consideration the potential market fluctuations while you are holding the carry trade. Depending on whether the market moves in the direction of the positive carry or opposite to it, you will realize a gain or loss beyond the leveraged interest rate differential.
So essentially, the best carry trades are ones that have an attractive interest rate differential and one in which you have a market bias as well in the direction of the positive carry. This would be an optimal carry trade situation. But keep in mind that carry trades are not without risk, so it is important that you have a solid plan in place if the market begins to move rapidly against your desired direction.
In this lesson, we discussed many different forex trading styles and currency trading techniques. Starting with the ultra-short term scalping method to the longer term macroeconomic and carry trading methodologies, along with many other trading styles in between. In addition, we discussed the use of discretionary vs automated trading systems and some of the characteristics of each.
With this knowledge, you should now be able to decide which trading style best suits your personality and couple that with a trade execution style that aligns with your temperament. For example, my trading style in the FX market is focused on a discretionary based swing trading style. This is what works best for me and I stick with that. Now it’s your turn to explore the different options available to you and decide the best combination for you.