Traders employ different trading strategies and trading styles based on their beliefs and knowledge of the markets. The thing about trading is that what works for a trader might not work for another and that is why different traders have different trading processes.
Thanks to financial innovation over the years, there have been many new additions to the world of trading and now traders worldwide have a much bigger space to choose their trading styles.
Essentially, trading styles can be attributed to the psyche of a trader. A reversal trader would find it extremely hard to follow a trend following the system and vice-versa. It is therefore important for traders to explore all types of trading before finally reaching the trading style that matches the personality and belief system of that particular trader.
With an attempt to introduce the various types of trading approaches, this blog explores the various types of trading based on trading strategies, timeframe and length of period the trade is open for, analysis technique based on the trade and the asset class traded.
(Must read: Basic trading principles)
Different Types of Trading
Based on Trading Strategies:
Momentum trading is a technique in which traders buy and sell according to the strength of recent price trends.
Here the traders look to find stocks that are high percentage and volume movers over a particular period of time, moving significantly in one direction and try to acquire the desired profit by taking positions in such stocks.
Momentum trading strategies seek to profit from buying stocks that are moving in an uptrend and selling stocks moving in a downtrend.
(Read also: Benefits of stock market)
Trading based on Mean Reversion:
The opposite of Momentum trading is trading based on the concept of mean reversion. This stems from the concept that stocks which deviate from their historic mean price will tend to revert back over a period of time to their mean value.
Traders can take long or short positions to profit from the mean reverting behavior of stocks. In contrast to momentum following strategies which work on the principle of buying high and selling higher (in an uptrend) and selling low and buying lower (in a downtrend), mean reversion strategies seek to capitalize on the classic buy low, sell high principle.
In general, momentum trading results in trades with low probability of success but high profit potential and trading based on mean reversion results in trades with high probability of success but low profit potential.
(Recommended blog: Intraday trading strategies)
The trading wherein the trader “scalps” a small profit from each trade by exploiting the bid-ask spread by darting in and out of a stock or other asset classes, multiple times a day to reap a small profit on each trade to add up to the big dough at the end of the day.
It is the act of buying and selling a financial instrument within the same trading day, or even multiple times over the course of a day, taking advantage of small price moves, such that all positions are closed before the market closes for the trading day.
Intraday trading and scalping provide traders with an opportunity to take leveraged trades and make more profits than usual. Leveraged trading is also the primary reason behind almost all of the intraday traders being unsuccessful over a longer period of time.
(Similar reading: Option Trading strategies)
Swing trading is a type of trading style wherein short-term strategies are played in the most liquid stocks or indices to take advantage of price swings, either reverting back to the median or fading a rally and last from one day to a few days to a few weeks.
As opposed to swing trading, the length of the trades is much larger for positional trading. Positional trading consists of trades lasting from a few weeks to a few months and sometimes a few years as well. Positional trading is as close to long term investing as trading gets.
In general, the probability of success keeps on increasing from day trading to positional trading. SInce the long term market structure is upwards for most of the markets, positional trades have a pretty decent probability of success.
(Recommended blog: Pros and Cons of Penny Stocks)
Based on Analysis Technique:
Trading obsessed with charts and graphs, monitoring lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals. Technical trading relies on technical analysis and is purely based on the price action depicted by an asset class.
Trading based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions. Fundamental analysis is more appropriate for longer term trades which avoid the short term price fluctuations or noise.
Trading based on both the technical and fundamental analysis is techno fundamental trading. In techno fundamental trading, a trader shortlists a few stocks based on fundamental analysis and strategically determines the entry and exit levels based on technical analysis.
(Learn more about fundamentals of technical analysis)
Equity trading is the buying and selling of company shares or stocks, also known as equities, on the financial market. Most equity trading refers to the buying and selling of public company shares through a stock exchange or as over-the-counter products.
As suggested by the name, derivatives are contracts that derive their value from an underlying asset. The underlying asset can be stocks, currencies, indices, etc. Derivative trading involves buying and selling of derivatives in a stock market.
Derivatives essentially enable a trader to bet on the future price movement of the underlying assets and are much more volatile than the underlying assets.
An interesting feature of derivative trading is that it lets a trader take much larger speculative bets and is therefore a lot riskier than equity trading. The two most common types of derivative trading include futures and options trading.
Currency trading or forex trading refers to the process of buying and selling currency pairs. Currencies are usually traded in pairs for e.g.: EUR/USD is the most liquid currency pair which provides the relative value of Euro to the U.S. Dollar at any particular period of time.
Other commonly traded currency pairs include USD/JPY, USD/GBP, USD/CHF, USD/CAD, AUD/USD, NZD/USD and USD/INR. A massive benefit of currency trading is that the forex markets are open all the time. Liquidity and the corresponding bid ask spread may vary at different time instances though.
Similar to equity and currency, commodities are widely traded assets. Commodities that are traded are typically sorted into four broad categories: metal, energy, agricultural and livestock and meat.
Metals commodities include gold, silver, platinum, and copper.
Energy commodities include crude oil, heating oil, natural gas, and gasoline.
Agricultural commodities include corn, soybeans, wheat, rice, cocoa, coffee, cotton, and sugar.
Livestock and meat commodities include lean hogs, pork bellies, live cattle, and feeder cattle.
Crypto trading or cryptocurrency trading refers to the process of speculating the future price movement of cryptocurrencies in an attempt to profit. As compared to the other asset classes discussed above, crypto trading is a relatively newer concept.
There are two routes to trading cryptocurrencies: speculating on their prices using CFDs or buying the digital currencies in the hope they increase in value.
This blog discussed the various types of trading based on four fundamental factors: trading strategies, trading timeframe, trading analysis and the type of asset class being traded.
A traders’ trading process is deeply correlated to his/ her mindset which in turn is dependent upon a variety of factors.
As opposed to a trading system which may be able to take different types of trades simultaneously, a trader will most definitely find it difficult to profit from successfully backtested trades provided they deviate from the core of the trader’s personality.
(Also read: Different types of insurance)
On the other hand, a trader would most definitely be able to beat a trading system when taking trades that sync with the personality of the trader which provide the trader with a natural edge.
Trading is in some ways more artistic than scientific and the art behind trading can be mastered by understanding and trying the different types of trading.