Trading Styles
Before getting into styles of trading we need to understand the volatility and movements of the stock/index which are known as trends/patterns. The general direction in which a stock or index moves is known as the trend. In other words, it is the movement of highs and lows that constitutes a trend. For example, an uptrend is classified as a series of higher highs and higher lows, while a downtrend is one of the lower lows and lower highs. A trend of any direction can be classified as short-term trend, intermediate trend or long-term trend.
The distinctive formations created by the movement of security’s prices on a chart are known as patterns. It is identified by a line connecting common price points (open, close, highs, and lows) over a period of time. Patterns in security prices may occur during different time frames (Intra-day, Daily, Weekly, Monthly or Yearly). Traders try to identify patterns to anticipate the future price direction. There are three types of trends:
- Uptrend/ Upward Trend/ Upward Channel
- Downtrend/ Downward Trend/ Downward Channel
- Sideways Trend
A trader can identify these trends and make trading strategies to earn maximum profit. Trading strategies depends on the attitude and trading style of the particular trader. It’s not necessary that stocks always moves in trends, it may move sideways but with big swings. Normally, it happens when there is a rumor or news in the market and traders can’t decide about the direction of the stock. Many of the good swing traders earn some very quick profits during these moves. On the basis of the movement in stocks, there can be two styles of trading, which are as follows:
- Trend Trading
- Swing Trading
Now, we will discuss in detail about both types of trading styles.
Trend Trading
It’s always said that trend is your friend. According to a study, the most successful traders in the world are trend traders. In a strong market, they choose a strong stock and look to buy it at good levels or vice versa. We can make good money in stocks that are trending. You want to find the stocks that are moving with the market, or have a good uptrend or downtrend. When a stock is trending – you are simply along for the ride. In other words, if the stock is trending up – you must be thinking of how I can buy this stock. If a stock is strong – you should be thinking getting long into it. Trying to short the tops in an upward trending move is a recipe for disaster.
ICICI Bank 28th Jan, 2009
If an upward trending stock pulls back, you should be looking for a good place to buy the stock. In the above graph – even if you bought the highs for the first 4 hrs. of every move – you would still be making good amount of money.
“Resist shorting stocks that are hitting new highs, or buy stocks that are trending downwards or vice-versa.”
What is a Trend?
A trend is nothing but the general direction of the price of a particular stock or market in general. A trend can apply to equities, bonds, commodities and any other financial market which is characterized by a movement in price or volume.
What are types of Trends?
Uptrend: Uptrend means rise in a stock without any pullback. A stock rising at an angle of 45 degree is said to be in an uptrend. Indeed, it’s very easy to make money in these types of stocks. But it’s very difficult to find out these kinds of stocks. Find a stock in uptrend buy it without wasting any time & hold as long as it follows the trend. The stock in uptrend makes a move as shown in the chart given below.
Upward Trend: Upward trend means rise in a stock with pullbacks. Generally, a stock doesn’t move in a straight line, it gives pullbacks. The ideal strategy for these kinds of stocks should be to buy at pullbacks. Trend traders wait for the stocks to pullback & create a position. Just have a look at the chart given below.
Upward Channel: Upward channel is formed when a stock rises in the format of Higher Highs & Higher Lows. Draw a trend-line joining the bottoms of the stock. Draw another trend-line joining the tops of the stock. It would form a channel. The ideal strategy here for a trend trader would be to buy near lower end of the channel & wait as long as it doesn’t break the lower trend-line of the channel. Example of upward channel is shown in the chart given below.
Downtrend: Downtrend means fall in a stock without any bounce. It’s very difficult to find stocks which are falling in a straight line. Ideally, a trend trader would find out these stocks & short-sell without any wastage of time. They hold the position as long as the trend will continue. Example of a downtrend stock is given below.
Downward Trend: Downward trend means fall a stock with bounces. Generally, in downtrend when a stock starts falling, it falls with bounces. Ideally, a trend trader would try to short-sell these stocks on bounces wait for the lower levels. Chart given below is an example of a stock in downward trend.
Downward Channel: Downward channel is formed when a stock falls in the format of Lower Highs & Lower Lows. Draw a trend-line joining the highs of the stock. Draw a trend-line joining the lows of a stock. It would form a channel. A trend trader would try to short-sell this stock near the upper-end of the channel & hold the same as long as it doesn’t break the upper trend-line. The example of a stock in a downward channel is given below.
Sideways Trend: Generally, there is no trend in these kinds of stocks. Stocks get stuck in a small range for a particular time frame. There are no tools for analysis of this kind of stocks. So, only one word is enough for trend traders in this kind of stocks i.e. ‘Avoid’.
What is Trend Trading?
The trend trading means trading with the trend of the stock. Trend trading is one of the most effective and easy to use methods for making money in the market. Trend trading success depends on identifying and catching the trend after it has started and getting out of the trend as soon as possible after the trend reverses.
It is very effective tool for day trading. Most of the times market moves in trends. If a trader can identify the real trend of a stock he can make money applying different strategies. As shown in the types of trends, a trend trader would follow different trading strategies according to the stock movement. It is well said that “Trend is your friend”.
Advantages of Trend Trading:
1. Trend trading is easy to understand & execute. There is nothing much to research. Most of the successful day-traders in the world are trend traders.
2. With trend trading the trader has a very favorable risk-reward ratio. The success ratio of a trend trader is better than other traders in the market.
3. Trend trading will help you to take larger profits out of the market without watching the market or stock tick by tick.
4. Being with the trend helps you to ride along the move. The concept of trailing stop loss can be very well executed in trending stocks.
Swing Trading
Swing trading is a style of trading where traders believe that a stock may take various swings during the day. We don’t have to stick to a particular direction in a stock. They believe in taking small profits & exit the position as soon as possible. This swing trading is different from what we discussed in types of traders. A swing trader would execute the following trades in different kind of markets.
- Uptrend: They avoid this kind of stock.
- Upward Trend: Try to buy on pullbacks & short-sell at the top.
- Upward Channel: Buy near lower end of the channel & short-sell near upper end of the channel.
- Downtrend: They avoid this kind of stock.
- Downward Trend: Try to buy near lows & short sell on bounces.
- Downward Channel: Buy near the lower end of the channel & short-sell near upper end of the channel.
- Sideways: Lot of buying & selling is done in this kind of stock.
What is Swing Trading?
Swing Trading takes advantage of brief price swings in volatile stocks to ride the momentum along with the flow of the orders. Swing trading combines best of the two worlds — the volatility of the stock & the momentum of the trend. Most of the swing traders hold stocks for few minutes. They are more of scalpers than day-traders. Swing Trading is a high-speed day trading. Some people call it momentum investing, because you are trying to play the momentum of the stock. By rolling your money over rapidly through short term gains you can quickly build up your equity. Swing traders are very active to change their direction along with the order flow from the market. Swing traders take small profit on every single trade but at the end of the day generally their closing number is big. They trade very high volumes as they try to capture each small move in the stocks.
How does Swing Trading work?
- The basic strategy for swing traders is to jump into a volatile stock to ride the move. They don’t play dead or low volume stocks.
- The stocks which are in strong trend often makes a quick move then consolidates or pulls back. Swing traders quickly enter into these stocks and take very quick profits. Often, they try to short-sell the stock where they exit their long positions.
- After making a pull-back the stock will again continue its trend. This process is repeated over & over again. One can also play on the short-side in a downtrend stock. The trader can make big profits in small moves. For example, if a stock has taken a move of 3%, swing traders can earn as good as 5%.
In brief a Swing Trader’s goal is to make money by capturing the quick moves that stocks make during the day, and at the same time controlling their risk by proper money management techniques.
What are the advantages of Swing Trading?
Swing trading combines best of the two worlds i.e. the volatility of the stock & the momentum of the trend. They can earn bigger profits in small moves.
Swing Trading works well for part-time traders, especially those doing it while at work. Swing traders hold a position for few minutes and take quick profits. But remember they can’t take their eyes off the screen as long as they hold the position.
1. While most of the Day Traders try to identify trending stocks to make money, Swing Traders try to ride “swings” in the market. Swing Traders buy fewer stocks and aim for bigger gains.
2. They pay lower brokerage and, theoretically, have a better chance of earning larger gains. Their total transactions are more but they book profits in most of their trades. Many small profits make it a big number.
In nutshell, swing trading is a very effective way to make money. The traders should have some qualities to become a successful swing trader. He should be active, assertive, adaptive, flexible & pragmatic. He should be a quick decision-maker. They have to be very fast in decision making & execution of the same.
Note of Caution: Whether you are a swing trader or a trend trader; always trade with a stop loss. Stop-loss is must for any kind of day trader. No trader can be successful without learning proper execution of stop loss. Swing traders keep targets & exit the position as soon as it is achieved or as soon as they sniff reversal of the trend. Trend traders keep riding their position with trailing stop loss & set higher targets. Indeed, swing traders design trading strategy with one stop loss & one target. Whereas, trend traders design their trading strategy with one stop loss & multiple target e.g. Target-1, Target-2 & Target-3.