It is the goal of almost any trader to reach a point at which you can consistently see positive returns from your activity in the financial markets. For the beginner, however, the trading learning curve is notoriously steep. One of the biggest undoings of the first-time trader is the lack of a plan to engage with the market. The result is often trades that arise out of arbitrary decision making, plain instinct and even fear.
A powerful strategy is not always a complex one: a simple summary of the markets you intend to trade, your criteria for opening a new trade (e.g. a breakout in a trend), how much you are willing to risk, and an idea of what needs to happen in order for you to close the trade at a profit (or a loss) will give you some guidelines to help you trade your chosen markets – and in doing so, will help you stand out from the rest. Here are the basics of trading and three easy-to-follow trading strategies for beginners that will help you to trade more like a professional.
While it is easy to get taken in by the highly complex world of technical indicators, it is more important not to lose sight of the components that make up a simple – and yet effective – trading strategy. An effective strategy relies on a combination of the following four elements:
- Managing your risk: Trading is an inherently risky business. At the outset, decide how much money you are willing to risk if a trade does not work out as planned. More experienced traders would say that trading is as much about keeping what you have got as it is about making money. You must be prepared to make a loss in order to make some gains. “Fail to plan and you plan to fail,” as the old saying goes.
- Managing your time: Financial markets can spend a lot of time trading sideways, leaving no clear opportunity to open a trade that fits your strategy. Sitting on your hands and waiting for an opportunity to show itself is an important discipline and can help you to build confidence to execute when the time is right.
- Understanding momentum: Staying informed and up-to-date with market news and current affairs is vitally important, as any event – like a shift in economic policy – can significantly impact the performance of your asset.
- Being consistent: With money involved, trading can also be an emotional business. You should grow to let your mathematically- and logically-informed strategy guide you rather than your nerves, fear, or greed.
At the same time, a successful strategy is also underpinned by a strong understanding of the following three ‘essentials’:
- Liquidity enables you to enter and exit trades easily - the cost of doing business is low in markets that see a lot of volume. They have a tight bid/offer price – the price at which you buy and sell. This is why markets such as foreign exchange, indices and commodities such as gold and crude oil are popular with traders.
- Volatility is an indicator of the range of your potential profit – and of course your risk. The greater the volatility, the greater the potential for profit or loss. Cryptocurrencies, like Bitcoin, are known for their high historical volatility.
- Volume is a measure of the amount an asset has been traded within a certain period of time (e.g. how much of an asset was traded in a certain day). High volume typically equals good liquidity and a low cost for entering and exiting a market. In addition, if volume increases, this can sometimes suggest a new trend may be about to begin.
Three easy-to-follow trading strategies
Breakouts are seen as an important trading strategy as their setup can form the starting point for a new major price trend.
A ‘breakout’ occurs when a market price breaches a defined level of support or resistance, often with increased volume. The breakout trader will either enter into a long position – purchasing a market with the expectation that the asset will rise in value – once the market breaks above the level of resistance, or into a short position — selling first and then buying later – once the market breaks below the level of support.
As soon as the asset trades beyond the price barrier, volatility can often increase and the trader hopes that the price will typically trend in the direction of the breakout.
Watching an asset’s support and resistance levels can be vital to determine the most suitable instrument to trade when using breakouts. If an asset price is hitting these points often, the more valid the breakout can be.
Next, determine your entry points. If the price is set to close above a resistance level, you will take what is known as a ‘bullish’, or long, position, seeking to profit from the rising price of the asset. If the price is set to close below a support level, you will take on a ‘bearish’, or short, position, hoping to profit from a decline in price.
You can use chart patterns to examine a market’s recent behaviour, using recent price action in order to calculate a price target. In one example, if the recent range of a price pattern is 3 points, then that amount could become the price target to project when the market breaks out (see fig. 1).
Fig. 1: A breakout of SNAP stock over a week in October 2017
Alternatively, you can calculate the average of recent price swings and use it to create a price target.
Once you have reached your goal, you can either exit your position or stick with it if you are expecting further gains.
2. Running out of steam
In the same way that you might view a drop to previous low as an opportunity to buy, you might also watch closely as a market begins to edge towards a previous peak. If the asset’s price increases but then stalls and begins to recede, it is typically viewed as a sign that the price is getting too expensive, or that it is ‘running out of steam’.
The trader of this strategy is looking to closely follow a price as it fails near a previous high before selling short in the hope of profiting from the fall in price.
Fig. 2: The price of GBP/USD approaching a previous high before running out of steam in May 2018.
One of the biggest advantages of using a strategy based on chart highs and lows is that your risk management is extremely straightforward. If you are looking to buy a bounce off a previous low, your stop-loss – the price at which you close a trade – can be placed below that point. If you are looking to sell short when the price begins to slide, your stop-loss can be placed above the previous high.
Considered one of the most straightforward trading strategies for beginners, trading ‘momentum’ centres upon a swift reaction to events in the news and identifying significant trending moves, often with high volume.
In theory, it is quite simple and effective: hold onto your position until you can identify signs of a reversal and then close the trade.
Fig. 3: A trend line showing a steady upwards move in the DAX in September 2018
However, momentum trading often carriers a higher degree of volatility than other trading strategies. Trading a momentum strategy with stop-loss and take-profit orders can help you to keep what you earn and exit your trades at the right time. Stop-loss orders will protect you from unforeseen price dips when trading a momentum strategy and ensure that you stay in control.
To get more on trading strategies, watch our video on trading breakouts: