Although we all employ different trading strategies across different time frames using different vehicles (stocks, options, futures, etc), there really are a limited number of pure trades we can take and it is helpful to know the major types and when we are employing them in our trading arsenal.
The four major types I propose are the following:
- Rangebound Fades
This simple chart I created helps illustrate these basic concepts:
When experiencing extended range consolidation, it is best to begin considering playing for a Breakout in hopes of a new, sustained breakout move. Recall that other traders will be attempting to “fade” the breakout and if price continues, they will be forced to cover. Stops are placed conservatively just below the breakout zone or aggressively below the area of most recent consolidation.
Retracements often have the highest probability of success when properly identified (trending environment). Core trading strategies (buy and hold until a top or price exaustion is formed) can be utilized as well as swing trading strategies which seek to capture the “sweet spots” in the data which generally are the distance from a retracement to a key moving average is confirmed up to the most recent swing high. Stops are placed conservatively below the support zone (moving average – yet these are frequently “gunned”) or aggressively below the most recent swing low.
Although Reversals have the lowest probability of success, when they truly occur, they can produce some of the largest profits if you capture near the true reversal zone. Realize that calling tops or bottoms is a losing game if you do not press your edge when the trade goes in your favor because your win ratio will be so low. It is generally not a good idea to fade a dominant trend even if you suspect a trend change due to a price climax. When fighting a trend, you must keep tight stops.
Finally, Rangebound or Fade-Trades occur when you have identified a rangebound, consolidating market. You are looking for channels and key support and resistance lines to provide you profit targets and close stop-loss zones. This tends to be profitable until a breakout occurs, in which you could endure large losses if you trade without stops. Realize that price expansion follows consolidation.
Typically, traders find it ideal to identify one set of trades or trade set-ups and play those whenever they recognize them, rather than trying to interpret compex signals and varying personal trading style or strategies on perceptions of possible market behavior. In other words, it might be best to identify which types of trades you are most comfortable executing given your psychological and risk tolerance and sticking to those strategies unless major market action intervenes.
Keep in mind that these trade types are applicable to technical analysis and short-term trading, but even fundamental analysts can benefit from learning basic market structure, especially trend analysis and volatility analysis. An ideal trade has a fundamental reason for buying which is supported by a low-risk entry provided by basic technical analysis and trend structure.
Nevertheless, in your own trading, identify which set-ups you take most often and see if they fit into any of these above patterns. Learning where you fit in the “Grand Game of Trading” can lift your confidence and give you that psychological edge needed over the competition who doesn’t study market structure.