by Amanda Harvey
Introduction
Stock trading strategy involves deciding which stock to trade,
identifying the optimal time at which to enter the trade, deciding on a
target profit, deciding whether to apply a stop limit and/or stop loss,
and exiting the trade at the best possible point. Strategy also includes
deciding on how much to invest in a trade, the size of the position to
be taken, and what its relationship should be to other trades in the
trader’s portfolio.
Strategy encompasses the trader’s general style of trading, tolerance
for risk, and risk management approach. It also covers aspects of
trading such as determining when to run with a winner, and when to cut
losses. It incorporates using strategies such as hedging to protect an
investment that is facing a possible loss, and increasing positions to
either maximize profit or scale down loss.
Selecting Stocks to Trade
The first aspect of stock trading strategy to consider is the selection
of stocks which present a viable trading opportunity. The two primary
methods used in picking stocks to trade fall into the broad categories
of fundamental analysis and technical analysis.
Fundamental analysis
examines the inherent value of the company in which the stocks are
offered. Using this method of picking stocks is well suited to investors
who wish to buy and hold investments over a medium to long-term period.
Stocks in companies whose inherent value is strong will usually reflect
this value over time.
Technical analysis
studies the movement of prices, and bases decisions on strong
indications of probable price movement. Technical analysis uses charts
and indicators as tools to provide insight into the anticipated future
price action. This type of stock picking strategy works best for
shorter-term investing, as studying price movement is unlikely to
provide any significant indication of what the stock will be doing years
later.
Entry Strategy
Once an investor has selected stocks in which they wish to invest, the
next stage of stock trading strategy is to identify the most favorable
time in which to enter the trade. Whichever form of analysis has been
applied to picking stocks, when it comes to pinpointing the best moment
to enter a trade, technical analysis tools can be very effective. Indicators
can assist a trader in recognizing the point at which a price is likely
to experience a breakout, retracement or reversal, and then, depending
on the trader’s style, they can take the action that they feel best fits
their approach.
Stock Trading Strategy – Position Sizing
Deciding how much to invest in any one trade is a vital part of trading
strategy. One way of deciding this is to allocate a certain percent of
available investment capital to each trade. This is a strategy employed
by Stock Options Made Easy in our Armchair Trader Membership
strategy. This means that if any one options trade is unsuccessful, the
trader’s overall success is not impacted unduly, as the winning trades
outweigh the losing ones in both numbers and percentage of profit or
loss.
Exit Strategy
Deciding when to exit a trade is an important, and sometimes difficult,
aspect of stock trading strategy. Using stop limit orders to secure
profit when the price reaches a target level - often a percentage
increase determined by the trader – eliminates both the indecision and
the need to constantly monitor prices. A stop loss order can help
protect against a loss greater than a predetermined percentage of the
investment, and helps to make the cutting of losses more clear-cut.
Other Aspects of Stock Trading Strategy
There are times that a trader needs to take measures in order to reduce
loss, or to maximize profit. Hedging is one such strategy, and this
often involves taking an options position as insurance against the loss
which may be incurred by a stock position. If a stock price is dropping,
a trader may buy a put option on that stock, which generally increases
in value along with the falling stock price. The gain realized from this
option trade helps to offset the loss experienced by the stock.
Other strategies that may be employed include pyramid trading, which involves increasing a position in order to run with a winner, or averaging down, by buying a further amount of shares at a lower price than was originally paid to lower the average paid for each share.
Conclusion
The stock market presents a myriad of profitable opportunities for the
investor or trader who is well informed, and understands and implements
the components required for a complete stock trading strategy. Knowing
which stocks to trade, how much to invest, when to buy, and when to sell
are all a part of a winning trading strategy.