What's Your Trading Style?

A while back I posted the article "Routine Becomes Habit". The premise of that post was to affirm the need for any individual who has an active stake in the markets to develop and maintain a successful investing strategy. Just as in life, each of us has a different style that suits our investing needs - the difficult part for many is finding that style.

I'll be breaking this topic into a few different columns, but the first is to lay the framework for how to determine which style may be best for you. All the nuances and unique details can be worked out at another time. What needs to happen first is an honest, well structured conversation with yourself. So, let's go ahead - start talking.

Are you a Day Trader? A Swing Trader? A 3-6 month trader? Do you fit the bill for a long term, value investor, holding your positions for a year, 3-5 years, or longer? Let's define each of those to be sure we understand what they mean. My definitions do not include every nuance involved with trading styles. This is a rough guide to help you think about your personality and how to classify your style of trading/investing.

Day Trader: An individual who initiates long or short positions in any security with a holding period of less than one trading day. No positions are carried overnight or, for futures traders, between sessions. They typically use charts with a time-frame of ticks, 1, 3 or 5 minutes. Because charts are fractal, day traders may look for patterns on a 10 minute chart that most other traders are accustomed to on a daily or weekly chart. These include head and shoulders tops, inverse head and shoulders bottoms, flags, candlestick formations, and many more. Most technical analysts harp on the perceived importance of where a security's price is in relation to it's 50 or 200 day moving average. Day traders couldn't care less. 

A day trader must be able to adapt and change their mind in a second - execute the trade first, ask questions later. Risk management (setting stops) is an absolute must on every position as losses in this business are guaranteed. The best day traders are those who may think the world will end tomorrow and at the same time initiate a long position on a stock without any hesitation, all because the charts say price is moving higher right now. In other words, they must be able to separate their opinion from the market action happening in the moment. 

If the above doesn't describe you, do not day trade.

Swing Trader: An individual who attempts to catch the inevitable ebbs and flows of security movements by establishing long or short positions with holding time-frames anywhere from a couple days to a few weeks. They typically use daily charts as a guide for identifying continuation or reversal patterns, while switching down to a 15, 30, or 45 minute chart for determining proper entry levels (the lower the time-frame, the earlier entry triggers fire off, but it depends on how aggressive a trader wants to be). Some use hourly charts, but I have never understood why anyone would want to use an hourly chart outside of Forex (trading hours are different than stock markets). Equity markets are open for 6 and 1/2 hours in a trading session. If I use a 1 hour chart, I will have 6 fully priced intervals, with the last interval containing only half of the price data as the other intervals. Over time, this will create flaws in the chart... but that is a topic for another day.

Depending on volatility, risk management is certainly implemented for swing trading, however stops are looser, typically allowing the price to move a bit farther than what day traders prefer. Swing traders often base trades on "symmetry" or measured move analysis. They derive price targets based on chart pattern breakouts, trend lines of support and resistance levels, gap analysis, fibonnacci retracements, and many more. Swing traders often base trades on earnings reports or other catalysts that are company specific or that affect a particular industry. Often, they are momentum followers, jumping on the themes that are attracting money at this moment, but are not afraid to make trades in anticipation of a quick reversal (i.e. occasionally trade against the trend when warranted).

3-6 Month Position Trader: This type of trader is an individual who is attempting to time the market's realization that the fundamentals of a particular security or industry in the market "are starting to matter." As a technical analyst at heart, I see this as a broad definition of what technical analysts actually do. Studying charts of short and long term time-frames is nothing more than an attempt to determine when demand is over taking supply or vice versa, and putting on a position, long or short, to catch the move in price. If price action is signalling a strong move is likely, either up or down, this can be seen as confirmation that the fundamental story behind a security is being realized by market participants. 

A 3-6 month position trader tries to identify sectors of a market where money is starting to move into (or out of), initiate a position, and ride the trend until signals show a topping or bottoming process is underway (cover shorts for bottoms, exit long for tops). Fundamentals, earnings, themes, and stories matter to this type of trader, but only when price actions begins to demonstrate that other market participants feel the same way about the story. Charts are an incredibly important tool in this trader's arsenal as price breakouts or breakdowns are signals for potential trend reversals. This individual may have a full time job outside of trading (this is quite typical), so most of their analysis occurs during evening or weekend hours. Keeping up with company reports, industry fundamentals, and exciting new developments in a particular market are of interest, however entering positions is based on daily or weekly charts with price breakout confirmations. 

Long Term Value Investor: This type of investor is almost solely focused on company or industry fundamentals, earnings reports, growth, PE ratio's, dividends, and a plethora of other factors that are used to determine the financial well being of a particular company or market sector. Rarely have I seen a long term investor use a chart (though some do) for position entries and exits, and there is absolutely nothing wrong with this. There are plenty of individuals who are able to profit quite handsomely without ever analyzing the market price of a particular security. A value oriented investor takes "long term" to the next level. These individual's attempt to snuff out unloved, poorly rated, or misunderstood areas of the market and pick up shares of a security at bargain prices with the goal of returning multiples of their initial investment or better, even if it takes 5 or 10 years. Stock's trading below tangible book value with a promising fundamental future are often the cheapies this type of investor seeks on a weekly basis.

Once you've determined in which category your style of trading or investing fits best, you can more easily draft a trading plan with goals and criteria that suit your needs. You'll be able to eliminate worrying about factors that really don't matter to you and will only add noise to your already volatile life. I'll touch on tips and tools to use for each type of trader in future posts, including some options strategies that can supplement each style. Until then, focus on the time-frame that fits your personality and ignore everything else.