Trading Strategy Definition

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Trading Strategy Definition

What Is a Trading Strategy?

A trading strategy is a methodical approach to purchasing and selling assets in the market. A trading strategy is built around predetermined rules and criteria that are utilized to make trading choices.

A trading strategy can be simple or complex, and it takes into account factors such as investment style (e.g., value vs. growth), market cap, technical indicators, fundamental analysis, industry sector, portfolio diversification level, time horizon or holding period, risk tolerance, leverage, tax considerations, and so on. The goal is to develop a trading strategy based on objective facts and research and to stick to it religiously. At the same time, a trading strategy should be re-evaluated and changed on a regular basis when market circumstances or individual objectives change.

Key Takeaways

  • A trading strategy is similar to a trading plan in that it considers many elements and criteria for an investor.
  • A trading strategy generally consists of three stages: preparation, trade placement, and trade execution.
  • Metrics related to the strategy are monitored and altered at each step of the process depending on market changes.
  • Most trading strategies are based on technicals or fundamentals, and they use measurable data that can be backtested to assess accuracy.

Understanding Trading Strategies

A trading strategy consists of a well-thought-out investing and trading plan that outlines investment goals, risk tolerance, time horizon, and tax consequences. Ideas and best practices must be investigated, embraced, and followed. Trading strategy comprises establishing techniques for purchasing and selling stocks, bonds, ETFs, or other assets, as well as more sophisticated transactions like as options or futures.

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Placing trades entails collaborating with a broker or broker-dealer to identify and manage trading expenses such as spreads, charges, and fees. Trading positions are watched and maintained after they have been completed, including altering or closing them as appropriate. Risk and return are calculated, as are the portfolio effects of transactions and the tax consequences.

Long-term tax consequences of trading are a crucial consideration, and may include capital gains or tax-loss harvesting schemes to balance profits with losses.

Developing a Trading Strategy

There are several trading systems, but they all rely on either technicals or fundamentals. The unifying thread is that they both depend on quantitative data that can be validated. To create trading signals, technical trading systems depend on technical indicators. Technical traders think that the price of a securities contains all information about it and that it moves in trends. A moving average crossover, for example, is a basic trading method in which a short-term moving average crosses above or below a long-term moving average.

Basic trading techniques consider fundamental elements. An investor, for example, may have a set of screening criteria in place to create a list of prospects. These criteria are formed by the examination of elements such as revenue growth and profitability.

There is a third sort of trading method that has recently gained popularity. A quantitative trading technique is similar to technical trading in that it utilizes stock information to make a buy or sell decision. However, the matrix of criteria that it considers to make a buy or sell decision is far broader than that of technical analysis. A quantitative trader employs numerous data points—regression analysis of trading ratios, technical data, and price—to exploit market inefficiencies and execute speedy trades using technology.

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Special Considerations

To minimize behavioral finance biases and assure consistent findings, trading methods are used. For example, traders who adhere to rules dictating when to quit a deal are less likely to succumb to the disposition effect, which drives investors to hang on to assets that have lost value while selling those that have increased in value. Trading techniques may be assessed for consistency under changing market situations.

Profitable trading techniques, on the other hand, are difficult to build, and there is a danger of becoming too dependent on a plan. For example, a trader may curve fit a trading technique to particular backtesting data, resulting in false confidence. Based on prior market data, the approach may have performed well in principle, but past performance does not guarantee future success in real-time market circumstances, which may differ dramatically from the test period.

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