A successful trader profits by actively taking the right opportunities, in both rising and falling markets. This is a different approach to the traditional buy-and-hold strategies and requires different techniques. Getting those techniques wrong may be an expensive mistake. So how can you get it right? There are some important fundamentals you should know before you take your first step into trading.
The trading style that will suit you best depends on several variables: the size of your account; the amount of time you plan to dedicate to trading; your experience; and your tolerance to risk. Not everyone will fit exactly into a certain style and some traders find a combination works best.
This style has the longest time frame and most closely represents the traditional ‘buy-and-hold’ trading model. This type of trader will hold positions over months and years, ignoring short-term fluctuations in price. Position traders make their investment decisions based on technical and fundamental analysis.
The key difference between position trading and traditional buy-and-hold investing is short trading. Buy-and-hold investors will only place long trades, which benefit from a rising market. Position traders do place long trades, but they may also place short trades, which generate returns when markets are falling.
Traders who do not have the time to closely monitor their positions are suited to this style. Investment decisions are based on the long-term time horizon, not on short-term fluctuations.
Swing traders operate on a shorter time frame than position traders. They tend to place trades over days and weeks instead of months and years, attempting to benefit from shorter-term market moves. Swing traders pay less attention to fundamentals, and more to technical analysis and movements in price.
This style of trading is also suitable for time-poor traders, who cannot constantly monitor every short-term market move. Swing trading is a very popular style.
Day traders – as the name suggests – enter and exit positions on the same day. All positions are closed by the end of the day’s trading, dependent on various criteria, including: if a profit target has been reached; a stop loss put in place; or a specific exit time given (for example, the end of the day).
Prices rarely move dramatically in just one day, so day traders use small gains to build profits. They typically trade on margin to build additional gains – effectively borrowing from a broker. This is profitable when the trader anticipates earning more from the trade than he is paying in interest on the margin (loan).
This type of trading requires constant monitoring and is not suitable for time-poor traders who trade as a hobby.
The speed and reliability of technology plays a major role in trading. You will need a high-speed internet connection, a reliable computer with a large memory and fully-charged back-up phones in case all else fails. An extra second here or there could mean you lose out on trades, while those with faster IT solutions profit. The shorter the trading time frame, the better the tech needs to be.
20 years’ ago, traders would call their brokers and place orders over the phone. This process could take minutes, in which time the market could have moved and gains lost. Today, traders can watch prices through their live data feed and make calls on positions to the second, minimising error. They just need up-to-date technology.
A trader’s technology needs to be robust. Traders should adhere to the following point to avoid any technology mishaps:
- Power. Ensure your computer’s processor is up to the job. A slow computer means a slow reaction to market movements so make sure your computer has significant processing power and memory.
- Software. The software on a trader’s computer needs to be able to cope with market analysis, testing and executing positions. Don’t get left behind with out-of-date software.
- Anti-virus. Keep your computer healthy by installing the latest anti-virus software and make sure any confidential information is well protected.
- Back-up plan. In case of emergency, keep a spare fully charged mobile phone should your computer crash and you need a way of contacting your broker immediately.
The broker you choose to work with matters too. Time and research will be required to find the right one. Trading platforms, such as Capital.com, allow you to transact efficiently, accurately and at a low cost. If you are unsure of anything, there is plenty of educational content on the website and an online support team able to quickly resolve any issues.
A trader will make a decision about whether to enter or exit a position and then inform a broker who will realise the trade. However, this process will inevitably take a few seconds and the optimum price may be missed in a delay known as ‘slippage’. Slippage is the difference between the expected price and the price actually realised. Various protective orders can be put in place to prevent this type of loss.
Long and short trades
A trader enters into a long position when they expect markets to rise. They aim to profit from a transaction where they buy stock for a lower price than they sell it. If prices move in the opposite direction – they fall when the trader expected them to rise – the loss on the position is considered ‘limited’ as prices can only go as low as zero..
Conversely, a trader enters into a short position when they expect markets to fall. This means that a trader borrows and sells an asset or instrument, agreeing to buy it back in the future (when prices have fallen to a certain level), therefore profiting from re-purchasing the same asset or instrument, but more cheaply. However, if markets rise and the prices move in the opposite direction, the trader’s losses are ‘unlimited’ as there is theoretically no limit at which prices could stop rising.
A market order simply instructs the broker to buy or sell at the best available price. This type of order will usually be realised immediately, so has the benefit of reliably fulfilling a trade. The drawback of a market order is that no price is guaranteed and there is no precision in market entry, so costly slippage can occur.
A trader places a limit order when they instruct a broker to buy or sell at a specified price or better. A buy limit order can only be executed at the specified limit price or lower, whereas a sell limit order can only be executed at the specified limit price or higher. The downside of this type of order is that if the specified price is not reached, the trade will not be filled at all and therefore a trading opportunity is lost.
A stop order to buy or sell only becomes active once a certain price has been reached (the stop level). A buy stop order is placed above the market, and a sell stop order is placed below the market. When the stop level has been reached, the order converts to a market or limit order.
A trailing stop is a dynamic stop order, following a price to buy or sell at a defined magnitude. The tighter the trailing stop, the more closely it will follow the price.
Stop loss orders
A stop loss order is where the risk limit for a trade is set. The trader is no longer willing to risk any more money beyond a predefined stop loss level. If it is reached, the trade will be automatically closed for the planned loss.
These are advanced trade orders which are automatically submitted or cancelled if certain pre-agreed criteria are met.
This type of order specifies the amount of time an order is to remain active in the market.
There are a lot of variables when it comes to trading. You will need a detailed and thoroughly tested plan which should be adhered to. Your plan should include factors such as: trading instruments; time frames; position sizing; and entry and exit conditions.
What to trade?
There is a wide range of markets that can be traded. Available assets are not limited to buying stocks outright. Futures, bonds, commodities, exchange-traded funds and forwards are just some of the markets which traders can access to trade on instruments such as currencies, crypto, indices, commodities and more.
At times, some instruments will be more attractive than others. Volatility and liquidity will help a trader to decide which market is right at that particular time. Both factors should be reasonably good for a trader to stand a chance of profiting.
A market can be considered liquid when orders can be executed efficiently and without causing a significant change in price. There are a few indicators traders can look out for to determine market liquidity:
· The bid-offer spread in a market is important. This is the difference between the highest price a buyer is willing to pay and the lowest price at which a seller is willing to sell. Spreads will widen in an illiquid market and narrow in a liquid market.
· Timing also plays an important role; traders should ask how quickly a large order can be executed. The quicker the speed of execution, the more liquid the market.
· Traders should also consider the depth of orders beyond the best bid and the best offer. A liquid market has sufficient depth to fill orders quickly and without causing significant change to the price.
· A volatile market price is one which moves a lot, and quickly. This price movement allows traders to profit, whether prices are going up or down. No directional trader profits from a flat market.
The level of volatility and liquidity can change across all markets. The suitability of assets will vary accordingly. Traders should design their own criteria to decide which market and when to trade it works best for them.
How long to trade?
A trader should consider their time frame before entering the markets. Those in search of a quick profit will need a different plan to those after long-term gains.
Short-term trading is generally associated with higher risk. Losses can be significant, but traders don’t have the luxury of time in which to recoup them. Short-term traders must be able to spot a good opportunity early, before it reaches the headlines and every other trader has taken the same position. Risk should be minimised and returns maximised by using stops (see the section on market orders) which limit losses.
How much to trade?
Position size refers to the value of a trade in sterling (or alternative currency) or the volume of contracts. A trader with little experience would be wise to start with a small position and build up to something more significant in time. Traders may want to expand a position only when a certain profit level has been reached.
When to trade?
The criteria at which a trader enters and exits the market should also be decided. Too conservative and you may miss an opportunity, too aggressive and you may make a mistake.
When entering positions, traders should create decisive criteria that suits them and their trading strategy. Many use trade filters and triggers to help. A trade filter outlines a series of conditions. If met, the triggers (which could include order type) are then applied and positions taken where appropriate.
Profit is made or lost when a trade is exited. Careful rules need to be adhered to ensure the right decisions are made and profits secured. Exit rules can include: profit targets; time exits; and trailing stop levels. Don’t be tempted to ignore an exit rule if you think profits might keep climbing, knowing when to take your profit is a key risk management tool.
Testing your plan
Before you execute your plan, it is important to test it and make sure it is robust. Run some historical data to see how your plan would have weathered over both the long and short term. Also test some forward data to simulate how your plan may work in a live market. You are looking for positive results with good correlation between back testing and forward testing.
You can place paper trades only in the beginning until you are satisfied your plan is effective. Many modern trading platforms also offer demo modes to help you test your strategies. Make use of them – test your trading strategy, try out the platform and find what works for you.
To get more on trading strategies for beginners, don't miss out our Trading Strategies palylist: