|How to Trade? - an overview of ways to trade|
Why Trade? - the Question you need to Ask before you Start
I think it is important that you have a basic understanding of the different ways to trading. It will help build your understanding of how the markets and the participants work. And it will give you trading and investing avenues to explore as well. I will discuss the following:
- Fundamental Trading
- Technical Trading
- Indicator based Trading
- Price Action Trading
- Discretionary Trading
- Rule based Trading
- Automated Trading
- Algorithmic Trading
- Quantitative Trading
- High Frequency Trading
|Trading based on Fundamentals|
Technical TradingTechnical Trading is trading based on price information only. It is build on the idea that all information that could influence a price is already reflected in the price, or priced in. The idea is also that all market participant have more or less the same information at the same time. This is called the efficient market hypothesis. Technical traders usually look at price charts and use technical analysis to come to their decisions on whether to buy or sell a security.
Indicator based Technical Trading
|Indicator based Trading|
Price Action based Technical Trading
|Price Action Trading|
|Using your Brain to Trade|
Rule Based TradingAt the other side of the spectrum of How to Trade, that is opposite to discretionary trading, is: Rule Based Trading. Rule Based Trading is best described as being 100% mechanical in analyses of the markets and execution of trades. This means that all trades are are entered and exited based on strict predefined rules. Systems traded this way need to be thoroughly back tested first by the person that will finally execute the system on a live account. This way the system can be followed rigorously without a doubt. Rule based trading systems try to take the emotions out of the equation when trading with real money. I have found it very difficult to rigorously follow system rules, even after manually back testing systems over large sets of data. This is a personal preference and it is why I trade discretionary instead of 100% rule based.
Automated TradingA way to assure rigorous execution of a (rule based) trading system is by (partial) automation of the analysis and / or the execution. One way of partially automating the execution of trades is by setting predefined exit-levels and than employ a set and forget trading regime. This means that at the time of placing the entry order, you will place two other orders that will be executed at certain price levels and get you out of the trade either at a loss or at a profit. Once the analysis is done and the orders are entered with your broker, you just go on with other important things in live, like working, cooking, etc. In addition to this you can automate the generation of the entry signals, so you will be send an email or sms whenever a trade matches your predefined entry rules. This can be done with trading platforms like for instance MT4 or TradingView. Please see the charting section of the resources page for links and more information. I use this way of trading sometimes if I do not have the time to watch the markets once I am in a trade.
Quantitative TradingQuantitative analysis is a form or technical analysis that looks at quantitatively defined events to find a "proven" or "tested" probability trading forward, also revered to as Quantitative Edge. At least that is how I define it. You can use an event profiler (I have written one in Python) to find events that have an on average high probability of being skewed to one side. Usually there is a natural underlying market tendency that is the basis that leads to an explanation of this quantitative edge. For example: an event is defined as "if today's closing price is 2% higher then last trading days closing price we mark an event". What we do is we take all the marked events that happened over the, let's say, past 10 years for a group of securities, we put them all on top of each other and then graph the average price behavior. So what you we do is, we look at price movement before and after each event over the past 10 years and record the average of these movements. This way we can learn if this kind of event leads for instance mostly to mean reversion or breakout patterns after the fact. Or in other words:
- Will price mostly move lower after a 2% spike higher, or will it continue to move higher?
- And for how long?
- And how far?
If you do not understand what I just tried to explain, then don't worry. I will go into this more deeply in later articles. For now I just want you to know about this way of trading / looking at the markets.
High Frequency Trading
|High Frequency Trading in action at co-location|
There are probably more ways of looking at trading, but these are the angles I use to look at the subject. Let me know in the comment section below if you like me to cover other ways of looking at it. By no means I mean to be the end all be all of trading and investing info. This is just my view on the matter.
Next in this getting started series
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