The mentality associated with an active trading strategy differs from the long-term buy-and-hold strategy found among passive or indexed investors. Active traders, in fact, believe that short-term movements help to achieve high profits. In this article we will see what types of trading exist, and the trading strategies associated with them, with examples and tips.
What are the types of trading?
There are various methods used to achieve an active or passive trading strategy, each with its own risks.
Scalping is one of the fastest strategies used by active traders. Basically, it involves identifying and exploiting movements generated by temporary imbalances between demand and supply.
A scalper does not attempt to exploit large moves or to make transactions with high volumes. Rather, they seek to take advantage of small moves that occur frequently, with low transaction volumes.
Since the level of profit per transaction is low, scalpers seek highly liquid markets to increase the frequency of their transactions.
PRO: Often, no strong technical background is required. Generally, it presents a lower market risk since it is possible to make transactions with low risks. It can still make a profit, even with small price changes.
CONTRO: Generally, it requires a high amount of orders with a consequent increase in transaction fees. Often, it requires a high initial capital to generate even modest returns (due to the small amount of profit per transaction). It is one of the most profitable strategies but requires a considerable amount of time to be set, due to the fact that a scalper must have total control of risks and their own emotions, or else total failure.
Day trading is perhaps the most well-known active trading style. It is often considered a synonym for day trading. Day trading, as the name suggests, is the method of buying and selling assets on the same day.
With day trading, positions are closed within the same day they are opened and no position is held overnight. Traditionally, day trading is done by professional traders such as specialists or market makers. However, the evolution of the internet and platforms has opened this practice to beginner traders.
PRO: Allows you to take advantage of daily volatility in the market. It is not subject to overnight risk. It is one of the most exciting and frenetic trading methods.
CONTRO: High transaction fees due to larger amounts of orders. Requires more time and attention for execution (even hours of waiting). Without a well-honed strategy and proper asset selection, it brings very low profits.
Generally, when a trend breaks, swing traders come into play. At the end of a trend, there is some price volatility as the new trend tries to assert itself. Swing traders buy or sell when price volatility increases. Swing trades are generally held for more than one day but for a shorter time than trend trades. Swing traders often create a series of rules or trading systems based on technical or fundamental analysis.
These rules or trading algorithms are designed to identify when to buy and sell an asset. Although a swing trading algorithm does not have to be exact and predict the peak or trough of a price movement, it needs a market that moves in one direction or the other. A sideways market is too risky for swing traders.
PRO: often requires less time and attention than day trading. It has a greater potential return per trade. It is able to trade even in the overnight market.
CON: can lose part of the profits while chasing part of the trend. It has a greater potential for losses per trade. It opens fewer positions and with greater investment, which leads to missing out on potential trading opportunities.
Many consider position trading as a buy-and-hold strategy and not as active trading. However, position trading, if done by an experienced trader, can be a form of active trading.
Position trading uses longer-term charts, from daily to monthly, in combination with other methods to determine the current direction of the market. This type of trading can last from several days to several weeks and sometimes even longer, depending on the strength of the trend.
Trend traders look for decreasing highs or increasing lows to determine the trend of an asset. Riding “the wave”, trend traders aim to take advantage of both rising and falling markets. Trend traders try to determine the direction of the market, but do not try to predict any price level.
Generally, trend traders jump on the trend after it has been established; when the trend breaks, they usually exit the position. This means that in periods of high market volatility, position trading is more difficult and positions are generally reduced.
PRO: less stressful than other forms of active trading. Strategies are easy to implement even with low financial leverage. Widely supported through technical analysis tools that indicate long-term trading signals.
CON: requires a strong background in technical analysis. Patience is often required to recognize the long-term price variation of an asset. It is subject to small fluctuations that translate profits into losses, but it is a relevant element of the strategy.
Before starting to invest in financial markets, it is necessary to have a solid trading strategy, a fundamental tool to invest professionally. It is up to us to choose the strategy that best suits our investment style, the important thing is to avoid trading without a well-defined trading system.
All of those who are making money from trading take all of these factors into consideration:
- Time horizon: We must establish whether we want to obtain short-term benefits or if our investment activity is oriented to the long term.
- Capital to invest: This aspect will make a difference since it is advisable to adapt the investment strategy according to the capital that we can invest.
- Risk level: Some strategies are riskier than others, so we must establish what level of risk we are willing to take.
To these aspects, we must also add the investment style that will define our trading strategy. Here is a simplified table:
|1||Price Action||Day Trading||90|
|4||Elliot Waves||Swing Trading||75|
|5||Bollinger Bands||Swing Trading||70|
1) Price action
The most used strategy in the world is the one based on support and resistance, called Price Action. It consists of looking at the chart and identifying at least a couple of areas of “resistance”, that is, a stop to the price increase, and a couple of areas of “support”, that is, a stop to the price decrease.
The two resistance lines are in red while the supports are in yellow. It is an intraday trading strategy, widely used in all types of instruments.
How to operate? Very simple: when the price reaches a support or resistance line it will be possible to wait for a break or a rebound. It will take a few minutes to understand if the price has the strength to break the support/resistance or if it will go back on its steps.
Here is a practical example:
Let’s assume that the price reaches the first resistance level. In this case, we will keep our eyes open and if there is a decisive breakout we will enter with a BUY operation, to take all the upward movement. On the contrary, if after touching the level it tends to rise, we will enter the market with a SELL to take advantage of the rebound.
It will be essential to correctly set our price lines, based on the minimum and maximum points reached by the price. A daily time frame is usually used to get the most out of this trading strategy, although some traders use the H4 timeframe to better define the market entry points.
2) Oscillator RSI
It is a scalping trading strategy, very easy to implement because it is based on the indications of a single indicator: the RSI indicator.
How is our RSI configured? In 3 ranges of values:
- 0-30: oversold
- 31-69: no signal
- 70-100: overbought
Let’s see everything directly on the chart:
How to trade with the RSI indicator? Operationally, there are two options:
– Oversold: indicates that there are too many sellers in the market, so a reversal is likely. In this case, enter the market with a BUY operation.
– Overbought: too many buyers and a saturated market. Easy to predict a price correction and then enter the market with a SELL operation.
Extremely practical and easy to implement, this trading strategy is one of the most used in the world. Experts recommend setting an H1 timeframe, while only scalpers will be able to set an M15 or M30.
The Fibonacci trading strategy was named after a historic trading icon. It is one of the oldest (and most profitable) in history. It is based on a range that will indicate the key points of the graph.
Based on complex studies and mathematical calculations, this strategy can be applied to the best trading platforms with great ease, thanks to a preset indicator. We believe it is a quantitative trading strategy, which lends itself well to the optimization of investment algorithms.
Here is a clear example:
How to trade with Fibonacci? These are the 3 steps to correctly apply this strategy:
- Find the maximum point
- Draw the line towards a historical minimum
- Trade near intermediate values
In this case, the operation is similar to that of Price Action, with support and resistance, depending on the break or rebound of the Fibonacci level. Don’t be afraid if you see all these lines on the graph, the indicator on the platform will calculate everything automatically!
4) Elliott waves
The Elliott Wave trading strategy is very popular among professional traders as it requires some skill to be understood but the results are generally excellent.
In plain words, the cycle is divided into different waves, which must be viewed on the chart in order to enter the market at the right time.
Based on the theory that history repeats itself, this technique allows to anticipate when the market will slow down or resume its upward march.
Of course, to perfect this methodology practice and study are required, however, as mentioned, the results are often satisfactory. It also lends itself well to medium/long-term operations, as the formation of the complete cycle takes weeks to be completed.
5) Bollinger bands
One of the trading strategies with a high probability of success is that of Bollinger Bands. Its operation is based on the channeling of the price within bands, which gives a very precise indication of volatility.
Trading within these bands has a very high success rate, as the complex calculations behind Bollinger allow us to better define the maximum movement of the analyzed asset.
How to trade with Bollinger Bands? It will be necessary to enter the market only when the price touches the extremes: with good probability, the price will tend to return within the range.
The MetaTrader 4 platform is the most suitable to establish this operational strategy, which is also suitable for medium or long-term investments.
Trading strategies are developed in an effort to get the best results for our investments.
A trading strategy does not need to be overly complex to be successful. However, it must be sufficiently robust and answer questions such as investment decisions, money, and risk management.
It is essential to keep in mind that it is not advisable to rely solely on a single investment strategy. It is much more appropriate to take advantage of different time frames to have at least knowledge of the strategies in each of them.
Even though we have compiled an extensive guide on the best trading platforms for active traders in the UK, we have drawn this table to summarise their features and advantages for your easy access.
|IG (Proprietary, MT4 or ProRealTime)||Advanced trading tools, direct access to many markets.||Learn more →|
|XTB (xStation)||Macroeconomic news, trading on more than 3,000 markets.||Learn more →|
|Interactive Brokers (TWS)||Advanced trading tools, and direct access to many markets.||Learn more →|
|FINECO (Powerdesk)||Advanced and complete features.||Learn more →|
|Pepperstone (MT4-MT5-cTrader and TradingView)||No minimum deposit. Demo account and great customer service.||Learn more →|
Differences and similarities between the various trading strategies
The previously mentioned strategies have different characteristics. Some require a highly analytical and technically valid background; others rely more on pattern configurations and a lot of time. In all strategies, it is necessary to have enough capital available to enter positions large enough to start increasing potential gains.
Day trading is not for everyone and for many, it is not the most profitable investment strategy. However, day trading is one of the most interesting strategies for buying and selling assets. In addition, there is no overnight risk. It can be profitable but, like all other forms of investment, success is never guaranteed.
Scalping takes advantage of price discrepancies, although it often requires more initial capital to realize greater profits and a strong emotional background.
Swing trading is heavily based on discovering trends within financial markets based on technical analysis. At the time of buying an asset, a swing trader often holds the instrument for a short period of time until it increases in value and until the trader’s target selling price. Entry and exit points are both predetermined before the operation based on the historical action of prices.
Position trading requires investors to hold assets for a certain period of time, which requires maintaining firm calm and patience.
How to understand which trading strategy is best for you?
Financial markets are a diverse world that offers many opportunities to make money through trading. The first question is where and how to start. Discovering what type of trader you are is a key decision to make when you start your trading career. However, it is also one of the most complicated decisions.
One of the most popular ways to differentiate between different groups of traders is based on the duration of each operation. A day trader buys and sells in a few minutes or hours. A scalper can hold an open position for a few seconds. A position trader holds the position to the limit of the trend, while a buy-and-hold investor thinks long-term.
Once the different types of traders have been identified based on the time interval in which they buy and sell, it is time to focus on the classification of the tools and methodologies used.
If you have heard of the debate between technical analysis and fundamental analysis, you already have the answer for the two main types of traders. Think of technical and fundamental styles as two different schools of thought, with their supporters and opponents.
Fundamental and technical traders differ based on the information they analyze and the factors considered in determining their strategies. While the former relies on fundamental information such as earnings reports, balance sheet analysis, and analyst ratings, among others, the latter uses indicators and charts.
The principles of fundamental trading and technical trading are often considered opposite. Even so, many traders and investors prefer to use both to better understand the market and the potential of their assets of interest. The reason for this is that both methodologies seek a common goal. In the case of stocks, for example, they find opportunities when instruments are traded below their intrinsic value or predict the potential for growth, and take advantage of price movements.
What type of trader are you?
The first thing you should do to choose your trading style is to analyze the basics and see what fits your profile best. Here are some questions to answer to support the decision you are about to make:
- Are you a beginner trader or do you have some experience?
- Which tools would you like to operate?
- Are you able to follow a work plan to the letter and control your emotions?
- How risk averse are you?
- Do you prefer to chase a single big win or build your capital gradually?
- With how much capital do you plan to start?
- With what frequency do you expect to monitor the market?
- Do you have a specific goal or do you just want to make money?
For example, if you are more conservative, more emotional or your capital is limited, becoming a scalper could be a disaster. On the other hand, if you are willing to take more risks and dedicate all the time necessary to monitor and analyze the market, day trading can be a great solution. However, if you have an investment goal, such as saving money for retirement, trading is not for you. Maybe it’s better to consider long-term investments.
In theory, answering these questions will give you a solid foundation to make a decision, but it is not enough. The best way to decide which trading style best suits your abilities and mentality is to try them all. When you do, make sure it is in a training field suitable for your capital. Trading different instruments through various strategies is challenging. It takes dedication and months, or even years, to master it, so don’t rush.
In the end, there are many different scenarios and combinations. The best way to find out which trading style best suits you is to recognize your style and approach. This way, you will feel calm and strong enough to stick to your plan and manage situations where market volatility makes you rethink your trading decisions.
Which trading style is best for beginners?
Beginners often start with swing trading or position trading for a less intense learning curve.
Can I start trading with a small budget?
Absolutely, but start small and focus on risk management to protect your capital.
Can I combine different trading styles?
Yes, many traders mix styles to diversify risk and achieve their financial goals.