The Three Core Trading Styles
Whilst there any many ways to trade the markets, we can broadly group them under three schools of thought which effects how a trader approaches the markets. Each group has their advantages and disadvantages, and many traders use a combination of these styles to form their unique approach.
- Fundamental analysis
- Technical analysis
- Automated trading
For example, some traders like to use fundamental analysis to generate trading themes and then use technical analysis to pinpoint their entries and exits. Others prefer to work exclusively with technical analysis (TA), or combine TA with automation for a semi-automated approach.
You will likely hear some traders argue “their method is better”, but ultimately it is for the trader to decide for themself which style they are more comfortable with. Besides, it is how well a method is executed which is more likely to produce better trading results, than the method itself.
For now, we will provide a broad overview on these three approaches, before covering popular trading styles within each group.
Fundamental analysis typically involves analysing economic data in order to decipher whether a market is undervalued (cheap) or overvalued (expensive). In turn traders then seek to profit from subsequent moves and anticipate whether certain markets will rise of all following an economic data release.
Three common forms of fundamental data include:
- Macro-economic data
- News trading
- Earnings reports
For many traders the economic calendar is central to their daily and weekly routines as they present a potential timetable for pockets of volatility. Economic calendars can also help traders draw up their watchlist for the week, as data from a specific region is more likely to move markets in that region. For example, the ASX 200 and AUD pairs are generally more sensitive to data from Australia and China, whereas data from the UK is more likely to move the FTSE 100 and GBP pairs.
As a rule of thumb, the larger the deviation between the forecast and actual number, the bigger and more volatile move we can expect from price action. For traders, the least interesting economic releases are when the final numbers hit the estimate, as the lack of surprise means little to no movements from the relevant market.
Economic data is useful to both day traders and long-term investors, as they can provide small bursts of volatility around the release or, on occasion, establish a sustainable trend over the coming days, weeks or months. As markets can be quick to react to the economic data, day traders quickly enter and exit the market around the time of the news release. However macro traders can also try to predict longer-term trends from the data.
Popular economic events which traders look forward to include:
- Central bank meetings
- Employment reports (NFP)
- Inflation (CPI, PPI)
- Growth (GDP)
- Business and consumer surveys (PMI’s, business confidence, consumer confidence)
News trading (fundamentally)
News trading generally involves reacting to market-moving headlines. Similar to economic data releases, the more of a shock the headline is to markets, the more a volatile a reaction is typically assumed to follow. However, headlines can come as more of a surprise as they generally have no warnings unlike an economic calendar, where traders sit there waiting for a specific report to be released.
Due to the unpredictability of headlines, news traders have to be highly organized and ready to act quickly. A trader would already have watchlists in place for potential scenarios so they are ready to act if a news event drives markets. For example, headlines for the Middle East tend to provoke a reaction with oil markets, or the actions of China’s central bank or government can directly impact risk assets such as global stock indices, AUD or the Chinese Renminbi. Furthermore, a news trader may have analysed price action of previous events to get a better feel of how volatility may be for similar events in future.
Whilst earning reports are stock specific, earnings season can make an impact on stock market indices so traders keep an eye on the earnings calendar to notify them when volatility could potentially increase. If we see multiple companies missing their estimates, it could weigh further down on the underlying index.
Technical analysis (TA) is the study of price action, volume and sentiment. A TA purist would strive to make all of their trading decisions based upon price action whilst ignoring the fundamental data. However, it is not uncommon for technical traders to take note of the economic calendar to either focus on specific markets related to the economic data or use the time around the data’s release to avoid trading certain markets.
Whilst we will not discuss how to perform technical analysis here (as this will be covered in later articles) we have compiled a list of technical trading styles which you are likely to come across. The list below is not exhaustive, but it does provide a broad overview of different technical styles. In some instances there are overlaps and of course traders are also able to blend styles together to form their own unique style.
- Trend following
- Mean reversion
- Swing trading
- Momentum trading
- EOD (End of Day) trading
- Intraday trading (day trading)
Trend followers use either price action (PA), indicators or a combination of PA and indicators to identify trends. The basic theory is that once a trend has been identified, the market is more likely to travel in the same direction until a change of trend has occurred.
Trends can be identified across all timeframes, from the monthly, weekly, daily through to intraday timeframes such as the hourly and 1-minute chart. This then means that traders could be trading in opposite directions yet still trading a trend of their chosen timeframe. For example, the 15-minute chart could be trending higher yet the daily timeframe could be trending lower.
Typical approaches to identify a trend are using a series if higher swing highs and lows (uptrend) or lower swing highs and lows (downtrend). Moving averages are also a popular choice to identify trends as they smooth out the price action. We will cover these techniques in greater detail in a later article.
Whilst markets can establish trends, they never move in a straight line and price action can fluctuate as it trends higher or lower. Its also widely recognised that data sets such as price action have a tendency to revert to their mean.
For example, if a strong bullish trend accelerates away from its 50-period moving average (MA), at some point price action will move back towards its MA. This could occur by price action moving towards the MA, or momentum waning which allows the MA to close the gap and catch up with price action. A mean reversion trader could look to profit by initiating a short position with the belief the price action will retrace and revert to its own MA (revert to the mean).
Under that scenario, the trader could also be called a “countertrend trader”. Yet mean reversion doesn’t necessarily have to be counter to the trend and can also be a form of trend following.
For example, a trader could identify a strong bullish trend, wait for price to retrace, then seek to “buy the dip” as they assume the bullish trend will continue.
As the name implies, swing traders seek to identify swing points on a chart and profit from the fluctuations between turning points. Like trends, swings occur on all timeframes. However, popular timeframes for swing traders are the hourly (60-minute) and daily charts.
As stock markets have a tendency to establish trends lasting weeks and even months, indices such as the Nasdaq-100, S&P500, FTSE 100 and DAX are popular with swing traders of the daily timeframe. However, they are also suitable on intraday timeframes such as the hourly or 15-minute chart.
To swing trade forex markets traders typically focus on the hourly or 15-minute charts as it provides more opportunities than the daily timeframe. Whilst swing trading the daily timeframe is possible, a trader needs to assess the volatility of the market to decide if the reward to risk is adequate enough to take the risk.
Refer to our full guide on swing trading for further information.
To trade momentum, traders are seeking to capitalise from bouts of volatility. It is usually a form of trend trading but in theory, traders could also seek countertrend moves if volatility reverses an established trend.
Breakouts are a form of momentum trading, whether the breakout occurs at a key level of support or resistance or even breaking out of a chart pattern.
Momentum traders would seek the strongest and weakest markets over a chosen time horizon to draw up their tradeable watchlist. For example, they could see how stock market indices have performed over the past four weeks and choose to seek bullish opportunities on the strongest performer, and bearish opportunities for the index which has the most bearish returns over that period.
Alternatively, a forex trader could use an MT4 indicator to show which is the strongest and weakest currency, then seek to trade momentum on the respective currency pair.
Timeframe Specific Styles:
Whilst the examples above are generally applicable across multiple timeframes, the following examples are specific to a time horizon. Ultimately your free time will likely dictate which of the styles you will veer towards, as your free time needs to be compatible with your trading time horizon.
EOD (End of Day) trading
This is a popular form of trading and can also be referred to as “set and forget” trading. The trader waits until the official trading day is over and seeks opportunities on the daily chart. They usually set stop orders, so a trade will be triggered if it moves through their entry level.
This style of trading is useful for traders who work full-time and have limited time available to be at their computer screens. For example, a UK based trader who works full-time might seek to place stop orders on the FTSE 100 after market close. Or traders in Australia might set EOD orders on the forex market early in the morning, just after FX markets officially closed in New York.
Intraday Trading (Day Trading)
Intraday trading simply means that a trade is opened and closed within the same day, so not held overnight. This typically means they are trading on the hourly chart and lower. For example, a trader could seek trends on the hourly chart and enter on the 5 or 1-minute chart.
A day trader could use any collection of the methods mentioned above. For example, they could be a trend trader, countertrend trader (mean reversion), news trader, swing trader or any combination of them.
However, unlike EOD trading, intraday trading requires more ‘screen time’ from the trader as they need to monitor markets to seek opportunities in real-time and be present to activate the trade manually.
Scalping is a specific form of day trading. Typically, scalpers will trade on the 1-minute or 5-minute charts and usually look to profit from very small moves of just 3-4 pips. As they trade in and out of the market so quickly at just a few minutes at a time, scalpers can trade multiple times throughout the session.
Scalping is highly screen intensive as the trader must enter and exit the market quickly to ‘scalp’ effectively. This also makes them particularly sensitive to larger, volatile moves so risk management remains as important as ever.
The lower the timeframe one trades, the more important the spread becomes as it has a greater impact on reward to risk ratios. This is why scalpers and intraday traders may want to consider the Pro Account as the spread is tighter, although a commission will also need to be paid to enter the trade.
Automated trading is becoming an increasingly popular form of trading. And part of the reason is thanks to MetaQuotes making automated trading the more accessible to retail trades around the mid 2000’s.
An advantages of automating a trading strategy is that it removes human emotion from the trading process, so can potentially lower the risk of human error, missing trades or overtrading. However, a caveat to consider is that errors can still be made with the coding of the strategy, which of course can negatively impact a strategy’s performance.
The two main methods to automate your trading are with MT4 EA’s (expert advisors) or using a trade copy service such as MT4’s ‘signals’.
‘Signals’ is a trade copy service which allows you to mimic trades from a list of trade providers. There may be a fee to sign up to the service ad of course a live account would need to be funded.
Historical performance and trade statistics are available to view for each signal provider, and they can be ranked using certain metrics to help choose the provider who is in line with your risk tolerance.
Signal providers can be either discretionary of automated but, as the trades are copied to your trading account, the service is still considered to be automated by the time the trade is copied to your account.
- To view available signals, click on the ‘signals’ tab at the bottom of your MT4 terminal
- You can rank the signal providers by clicking on the column headers. For example, rank them from highest to lowest ‘Growth / Weeks’.
- Click on a signal provider to see more detailed information on their performance, risk metrics and the strategy.
MT4 EA’s (Expert Advisors)
Expert advisors are the creation of MetaQuotes, and they allow traders to automate trading strategies or build complex dashboards within their MT4 terminal. EA’s are coded with MetaQuotes’ proprietary language MQL4 from within the MetaEditor and can be backtested using historical data using MT4’s strategy tester.
There is a comprehensive manual for the MQL4 language and a huge, global userbase of coders will to help each other. And the good news is that ‘EA builders’ are available which can also help newer traders with no coding experience design their own automated strategy.
The four main methods to create your EA include:
- Code your own EA’s
- Pay someone to code your EA’s
- Exchange EA ideas online for free in forums
- Use an Expert Advisor Builder
Two EAs are supplied with MT4 by default and can be accessed via the ‘Navigator’ window within MT4. However, you can also view a selection of free and paid EAs from within the ‘Market’ tab. And as MT4 has a huge user base with a global reach, EAs can be downloaded for free from many MT4 and trading forums.
Today we covered three core trading styles of fundamental, technical and automated trading. It is here to provide with you a broad overview of the various styles and hopefully make you more familiar with some of the trading terms and their associated timeframe.
Over the coming articles we will delve deeper into some of the specific styles and demonstrate how to get involved yourself.