You don’t develop courage by being happy in your relationships everyday. You develop it by surviving difficult times and challenging adversity.
—Epicurus (341 BC–270 BC)
Philosopher of the 4th century BC
I have been told many times that trading is simple: Just follow the trend, as the trend is your friend!
The strategy is also simple: buy stocks in an uptrend, and when the trend changes downward, swap into another upward trend. In other words, always have your shares in upswings. Timing can be from a few hours to some months to even some years.
The next step to this strategy is to use an averaging methodology, which means that the trader keeps adding to his or her position as long at the share keeps rising. So, if your strategy is to buy 1,000 shares every time the share rises by 100 cents, then your total exposure would be lower than the sum of the acquired shares. Then, when the trend is near a perceived end, you sell all the shares in that upswing.
The following example highlights the averaging strategy of day trader A:
Trade number |
Quantity bought of Company X shares |
Share price (cents) |
Cost |
1 |
10,000 |
100 |
10,000.00 |
2 |
10,000 |
120 |
12,000.00 |
3 |
10,000 |
125 |
12,500.00 |
4 |
10,000 |
138 |
13,800.00 |
5 |
10,000 |
150 |
15,000.00 |
TOTAL |
50,000 |
152 |
63,300.00 |
Trader A bought 50,000 shares in Company X at a total cost of 63,300 dollars. So, divide this cost by the number of shares bought (50,000) and you get a share price of 126.6 cents a share. He or she then sells the entire holding at 152 cents a share, which means that he or she received 76,000 dollars, which is a profit of 12,700 dollars or a 20 percent profit margin.
Often during share mentoring workshops, I am told that trend following is only for long-term investors, which is just not true, as many futures traders today use this method of trading. The basic system is to go long before positive news events and to go short before negative news events. The trick, of course, is to know whether news events will be positive or negative. This is the domain of the all-too-important field of fundamental analysis, which I have written about in numerous books. If you need information about such books, go to www.magliolo.com.
• The main benefit of trend trading is that an obvious trend is easy to spot, it allows the trader to ride a security for easy to identify gains.
• The main disadvantage of trend trading is that an obvious trend is the one that has already offered other traders the same growth opportunity. If you expect to achieve 20 percent growth from a particular strategy, expect less than half the growth. This usually translates into a strategy that is only half as beneficial as first forecast.
Another misconception is that a scalping strategy is the preferred territory of day trading. In fact, if you want to associate timeframes to strategies, then scalpers will usually hold positions for up to several hours, while another form of trader—the swing trader—will hold his or her positions for a few days at a time, and position traders will hold them from several weeks to years.
One way of determining which type of trader you are, just choose a timeframe with which you are comfortable. Defining your style is important to your success as a trader, so look at the following timeframe forms of trend traders.
Forms of Trend Trading
There are four types of traders if style is related to timeframe and related strategies. The scalper’s strategy is to hold positions the shortest, followed by swingers, core traders, and finally, position traders.
These are set out as follows:
The aim of scalp trading is to make numerous trades with a continuous stream of small profits throughout the day. The strategy is deemed successful if you are able to make small profits with less risk per trade. Due to making many trades, it becomes difficult to monitor all positions, so the advice is to have a tight stop loss on each position.
However, this form of trading does require strict discipline and focus, which can make a trading day tense. If you cannot concentrate on many trades that are spread across global exchanges, then scalping is not for you.
Scalping is, thus, fast, exciting, and requires an ability to make decisions without hesitation. My recommendation is to use scalping to profit from anomalies in price and a company’s true value. Thus, before you even begin to scalp, research which sectors on global markets are at their most volatile. Ask: what’s happening in the world economies. Then, look at correlations between shares, sectors, and general markets. Once you have done this, check daily charts to identify resistance levels.
Remember that you are looking for opportunities with low risk and high-earning potential.
Before scalping, check the following:
If the objective of scalping is to trade in and out quickly, are there strategies? Do you, in fact, actually need strategies?
A choice is to trade breakouts, but such trading is difficult and requires absolutely perfect timing. There is a substantial risk to being long or going short too quickly, and therefore, you risk the possibility of the trend not being as substantial as you expected. In fact, what if the trend turns against you at the very start of a trend? One strategy is to offset this risk by having a two-stage approach to acquiring stocks: scalp only 50 percent of your intended funds, and the remainder when the trend is confirmed.
As part of your trading journal and strategy objectives, use the following:
• Objective: Achieve regular small profits on small price fluctuations.
• Trading timeframe: Trade an average of seven to 10 times a day, but never more than 12 times and a minimum of three times. Hold positions for at least two hours, but a maximum of six hours.
• Trade execution: Only trade in electronic markets with auto-queuing systems.
• Network connections: Get the fastest and most efficient system available anywhere in the world.
• Continuous research: After hours and specifically before markets open, I will prepare by undertaking market research so that my trading decisions are with sufficient knowledge. I will always analyze key drivers that may prevent a stock from moving, staying neutral, or rapidly rising or falling.
• Never chase: My stock choices will be based on my research and experience, and I will not chase the market or conduct popular trades.
• Closing positions: As scalping is quick, I will not hold overnight positions. Before the end of the day, I will take profits or losses.
True scalpers exit positions quickly if the market does not go their way. Do not hold onto a losing position hoping it turns around!
Swing trading requires, in my opinion, extreme patience as you need to combine fundamental analysis with daily bar charts to help to time your market entry. In addition, most swing traders are well capitalized, which allows them to diversify among different global markets, and thus reduce risks of declines in any single market. Being well capitalized means, of course, that you have substantial funds available to you to trade.
I have spent much time in trying to find out what funds a professional swing trader has at his or her disposal, with little luck. In the United Kingdom, many swing traders use 100,000 pounds, while U.S. traders use 100,000 dollars—both the same in number, but different in value.
Due to being a corporate finance advisor, I like this form of trading, as it frees me from my trading screen for long periods. So, if you can place a trade and walk away from the screen without being nervous or anxious, I would strongly recommend this style of trading.
Compared to scalping, swingers hold their trades longer in the market, and thus tend to be less intense type of people. In fact, while scalpers look for small profits from many trades, swingers search for intra-day trends or trend reversals to capitalize on price moves.
New technical analysis packages enable you to compare and cross-reference, among others, daily charts to intra-day chart patterns. If you like this form of trading, I recommend that you keep your eye on factors that influence investor sentiment. Start with sector analysis and move onto assessing peer companies’ price-earnings ratios. Under such conditions, weaker companies will see shares falling, being replaced by the stronger peers.
Core Trading
Unlike the aforementioned two traders, core trading takes advantage of anomalies in the market that require time to become established. Professional core traders assess—after hours—the environmental factors of business, economics, technology, and politics to make trading decisions. The challenge with core trading styles is the ability to inherently understand markets and what influences such markets.
Consequently, you need to be more experienced as a trader and analyst to succeed under difficult global market conditions. With patience, great profits are, however, possible.
As part of your trading journal and strategy objectives, use the following:
• Mindset: Keep abreast of long-term trends that influence global markets. Understand that many global factors do not transcend between exchanges.
• Have accounts related to different securities: As an active day trader, you need to have separate accounts for intra-day transactions and longer-term equity positions.
• Daily analysis of indices: Daily analysis of global market indices is required: S&P 500, Nasdaq, Dow Jones, FT-100, Nikkei, and Hang Seng.
Look at global crossover markets as potential targets. If the Hang Seng breaks a support level at the end of its trading day, will the FT-100 do the same?
Ask the question: Is the breakout a movement toward a longer term bull or bear trend?
Always keep to your own developed rules.
Manage risk by buying stronger stocks and selling weaker ones.
• Analysis
Technical: Follow daily and weekly charts based on technical indicators. Use resistance levels, moving averages, and volume trends.
Fundamental: Follow business and economic analysis and news. This is very beneficial if you assess your own analysis relative to those expounded on the news channels. The aim is to determine whether such news can create or promote a dominant trend in the stock market.
General knowledge: Core trading does require more
in-depth knowledge of a company before you buy its shares. In addition, you need to assess a company relative to its peers, sector, and the overall market. As such, this form of trading requires more research and analysis than swingers or scalpers.
• Stop loss strategies: Keep reward-to-risk and stop loss ratios wide. I suggest start at 15 percent and close that ratio to 8 percent as your long-term position moves into profit. Relate your stop loss to resistance levels.
• Greater profits: While core traders are focused on longer-term trends, there is an obvious strategy to improve profits: use entry and exit points based on intra-day price swings and resistance levels. Essentially, if you are able to buy before an upward price movement and sell once the trend has been expended, you will make more profits.
Position Trading
Such traders will hold positions for months to years. Usually associated with institutional buyers, position traders require extreme patience. Often, position traders are also short-term traders. Essentially, they have several accounts, including a long-term portfolio and a trading account to buy or sell futures, options, and forex.
Remember, institutional traders often have large billion dollar positions, so they can influence the movement of share with large orders. These traders use technical analysis (weekly and monthly charts) and fundamental analysis to manage portfolios.
Discretionary and System Trading
Once you have determined what trading timeframe and style you wish to adopt, you then need to define if you are a discretionary or a system trader.
Both are defined hereunder:
• Discretionary trading
Definition: Trading decisions are based on your research and analysis.
Such traders still follow a trading plan. Ultimately, such traders use fundamental analysis to determine what to buy and then confirm the trades with technical analysis.
Consequently, they decide what and when to buy.
• System trading
Definition: Trading is based strictly on technical rules.
As such, the trader follows rules without any discretion. This is also called black box trading and can lead to making erroneous decisions.
Many fund managers use these systems to trade, and as such, you need to keep an eye on institutional trading, as these will influence market conditions.
So, if a black box trade is made in error—as happened in 2010 when the Dow Jones was hit with an error trade of a U.S. billion dollar instead of a U.S. million dollar sale—the market will be influenced.
Under such conditions, you can make significant profits from system traders’ miscalculations.
By identifying and adopting a style and timeframe to trade across global markets, you establish a formula to remove emotions from your trading plan. The alternative to not having a timeframe is to allow yourself to trade at will, and ultimately, you will see more losing than profitable streaks.
The final chapter sets out conclusions and last words of advice.