Volatility is an inevitable part of the stock market. The unstable nature of the stock market allows traders to earn financial gains by taking the advantage of rising and falling market prices over a short time frame. Traders make frequent transactions seeking the financial gains over a specified period, and usually use a protective method, stop-loss, to close out losing positions at a predetermined price level. Traders often employ technical analysis tools to make profitable returns. On the other hand, investors often employ long-term strategies (esp. buy and hold strategy) to seek financial profits.
Traders use different strategies using candlestick charts and moving averages and stochastic oscillators to beat the market and profit by the swings of the market. Some of the most popular and effective trading strategies that are tested and proven over time are given below:
5 Best Trading Strategies For Stock Traders
A. Momentum Trading
Momentum trading means riding with the tide. In momentum trading, the trader buys the stocks which are rising. Momentum stocks are difficult to identify. According to warrior, ‘only maybe about 10 out of 5,000 will fit the criteria in a given day.’ The qualities to look for to make momentum trading are:
- Fundamental catalysts such as company’s earnings, PE ratio, dividends announcements, or any other breaking news. Sometimes rise in stocks price can be seen without any fundamental signal, this is called a technical breakout.
- High relative volume, usually 2 times than the recent volume. Breakout with high volume is considered is a strong signal for a true breakout.
- Breaking of the prices above moving average.
- Stocks with a small market cap or fewer few shares tend to rise faster than large-cap stocks. So, look at stocks with less than 100 million floated shares.
Stop-loss is placed just below the buy price. If the price falls below the predetermined price, momentum traders sell the stocks to avoid heavy losses. Stop-loss acts as insurance against a false breakout and heavy loss.
B. Pullback Trading Strategy
A pullback trading strategy is applied to stocks with established trends. Stocks with consecutive resistance or support levels or respecting the trend lines or moving averages in established trends are best suited for pullback trading strategy. The pullback is the short-term price movement in the opposite direction in a long-term trend.
If the established trend or long-term trend is upwards, then the downward price movement (pullback) is the entry point for the traders. If the pullback doesn’t respect the previous pullbacks or trend, it might be the reversal of the trend. The reversal can be confirmed by a breakout with a high volume in the opposite direction. In the case of trend traversal, a stop-loss can be placed just below the determined trend line. Different technical indicators can be used to place stop-loss like moving averages, Bollinger’s Bands, RSI (relative index), trend lines, etc.
C. Scalping Strategy
Scalping is a trading strategy of profiting from small price changes making little financial gains in many and frequent transactions which add up to make a large sum. Scalping trading requires sharp and strong technical skills related to candlestick patterns and other technical indicators and one must act quickly and wisely. A scalping trading strategy is not recommended for beginners as it carries a lot of risks. Timing is everything in this strategy. It needs a strict exit (sell) strategy to avoid huge losses. A huge loss can undo all the financial gains earned by many little profits made using scalping.
Scalping a trading strategy requires a lot of transactions, so it can act against your disadvantage if the breakage fees and commissions are high. The profits will be taken away by the taxes, commissions, and fees. Scalping traders make quite several transactions/trades in a day. The scalping strategy is most suited to those who have a strong thought process and can act without dwelling.
D. Breakout Trading
A breakout takes place when there is sudden price movement above the former resistance or below the former support. A breakout with high volume (usually twice or more) is more sustainable while a breakout at the same volume may be a false breakout. A breakout above the resistance is a buy signal while a breakout below the support level is a sell signal.
Breakout can be identified by using different technical tools like candlestick chart, volume chart, moving averages, Bollinger’s Band, and RSI (relative strength index). An example of uptrend breakout would be stock rising above 50 days Exponential moving average (EMA) supported by high volume. The breakout strategy is applied by both traders and investors. Breakout trading strategy can be very profitable when protected with stop-loss.
E. Swing Trading
Swing trading focuses on attaining short-term profits from the swings of the capital market. Swing traders may hold onto the stocks for days to several weeks. In swing trading, a predetermined target price is set and stop-loss is placed using technical indicators or price trends.
Traders use a technical approach to analyze the trading opportunities in the swinging market. But fundamental analysis is not discarded while choosing stocks. A swing trader looks for multi-day chart patterns involving moving average crossovers (golden cross and death cross), head and shoulders patterns, flags, rectangles, and triangles. Key reversal candlesticks patterns may come into as a strong trading strategy to achieve short-term profits. There is always a chance that the swing traders might miss long-term trends and might sell off too early depriving them of huge profits.
Mathematics professor Jim Simons, founder of Renaissance Technologies (1982) is a swing trader. Since 1988, Simons’ Medallion Fund has generated average annual returns of 66% before fees.
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What is Day Trading? Is it Possible in Nepal?
Day trading is the act of buying and selling stocks or securities within a day. Day trading involves taking advantage of small price changes and movements in the market. Day trading is very risky and recommended only for professionals. But day trading is not possible in Nepal as it takes at least 2 days for the completion of a transaction.
The traders have been able to beat the market by using the available technical indicators effectively to execute their trades and earn huge financial gains. Lower brokerage fees and commissions are very important while considering frequent trading otherwise your money might be wiped away slowly like a washing soap. Moreover, traders need to pay higher taxes (50 % more) than the investors in Nepal. Still, active traders have outperformed the market using the above-mentioned trading strategies.
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