Trading Styles

It’s important at this point to have an idea of the different types of market participants as these determine the trading style.

Trader vs. Investor
Technical Analyst vs. Fundamental Analyst
Mechanical Trader vs. Discretionary Trader
Revenue vs. Growth

Let’s look at the key differences.

Trader vs. Investor

(For clarification, the use of the word instrument or asset means the same as a stock, futures contract, a commodity, Forex, an option, a CFD or any tradable instrument).

An investor has a different need for using the markets than a trader. Most invest their money in a business. What this business does is important but more so how well it does financially and directly influences the decision of the investor as to whether or not they will choose to invest in it. Their method of investing is the same though, as they still purchase shares, but they do so for the very long term, and in many cases will never sell. A good example is Warren Buffet. To read about Warren Buffet visit http://en.wikipedia.org/wiki/Warren_Buffett

Another type of investor will invest in a long term economic outlook; for example investing in a country, a commodity or a currency and holding that position for many years. If they believe the outlook for a commodity is that the supply is diminishing and demand is increasing, they will look to invest in that commodity, until such times as the supply starts to exceed demand placing downward pressure on price. A good example of an investor such as this is Jim Rogers. To read about Jim Rogers visit http://en.wikipedia.org/wiki/Jim_Rogers

A trader on the other hand has less understanding of businesses fundamentals, or an economic outlook, and in most cases doesn’t want to know. Their main objective is to make money on any price differentials an asset will make over a period of time, usually based on technical analysis and not fundamental analysis.

Technical Analyst vs. Fundamental Analyst

Technical analysis is the use of charts and indicators that enable the trader to get a visual representation of the movement of any instrument. What needs to be understood with technical analysis is that its major edge is in trying to decipher emotion and psychology in the market place (more on this below). Fundamentals can not do this as well as technical analysis, because fundamentals are based on a long term supply and demand equation, the economy, and the internal finances of a company.

When one looks at a chart of any instrument, the longer the time frame the more fundamental is the reality (or slope) that the instrument is going in, yet the smaller the time frame the more psychological and emotional is the reality. In other words, the smaller the time frame the more prices are being pushed by human emotions and less by fundamental forces. Technical analysis aims to read, chart and predict prices based on the premise that emotions swing from one extreme to the other and are repetitive in nature, much like human emotions.

In this chart we aim to demonstrate that the red line is based more on an underlying fundamental reality, yet the oscillations of price around the red line are based more on emotions of the market participants.

Mechanical Trader vs. Discretionary Trader

When a trader is using technical analysis, they are going to be approaching the markets, and thus their analysis from one of two angles; they are either going to be a purely mechanical trader or a discretionary trader. It is quite possible to use a combination of the two, but in reality, as soon as you add discretion into your system you stop being a purely mechanical trader.

A mechanical trader uses a set of rules that basically filter out instruments to the point where one to a few remain. Because these one to a few remain, they are traded. There is no discretion in any of the filtering rules (only in creating them in the first place), and there is also no discretion in whether or not to trade an instrument once it passes all the rules. The fact that it passed through every rule means it will be traded.

The point of a mechanical system is to remove as much emotion as possible and also decisions, as decisions can often be affected by emotions. If a trader is allowing their emotions to affect their trading decisions, they stand less chance of success. It also removes the need for analysis beyond the simple indicators that are used as filters.

Some of the benefits of a mechanical system are as follows:

1. Removes having to make decisions
2. Removes having to pay attention to detail
3. Removes having to analyze
4. Removes more of the emotional elements attached to the three above
5. Can be less time consuming, due to not having to do the three above
6. Can be back tested with far more ease and no subjectivity

A distinct strength that can be observed from mechanical trading is mathematical probability, as this is what gives mechanical systems their edge. If you have strength in math, in particular probability, then it won’t take you long to see the huge benefit a mechanical trading system can have for you. One of the most famous stories of mechanical trading success is the Turtle Traders.

A discretionary trader on the other hand has a need, a passion or a love for detail, analysis and decision making. It can also be said that a discretionary trader will have a better handle on their emotions. A discretionary trader will also have done more research, more learning and understanding of their method of analysis and the tools they use.

A discretionary trader may also use a combination of fundamental analysis and technical analysis, depending on their time frames, their objectives, and their knowledge level and so on.

A discretionary trader may also look to use their analysis in form of building evidence. Using a checklist or similar, they will gather evidence from all their analysis to determine if a possible trade exists or to support a possible trade.

One of the more famous methods of analysis that would have to come under discretionary trading is Elliott Wave Theory. To read more about Elliott wave visit: http://en.wikipedia.org/wiki/Elliott_wave

In a way, the key difference between mechanical traders and discretionary traders, other than their level of experience in certain areas of trading, is that mechanical trading looks to remove or manage weaker areas of a trader (such as decisions making, analysis), where as discretionary trading looks to use the strengths the trader possesses, should those strengths lie in time available, emotional discipline, analysis, attention to detail and the ability to make decisions.

So what are some examples of the sorts of people who would prefer a mechanical system?

• People who don’t like to have to make decisions
• Or the decisions they make are based on as little detail as possible
• It’s either a trade or it isn’t
• Lack confidence in their ability to analyze
• Don’t like having too much information
• Want as little emotion involved as possible
• Have less of a need to be right

And what are the sorts of people who prefer a discretionary type system?

• Have confidence in themselves and their analysis
• Good decision makers
• Like to analyze and process lots of information
• Like paying attention to detail
• Have more of a need to be right

So which are you? Trading with a mechanical system is by far the easiest way to trade but it may not be the most fulfilling either. If you plan to make trading the markets and being a market analyst your life long career, a mechanical system will be extremely boring for you, unless you set it up for making money and leave it at that. You can then spend the rest of your time being a market analyst and enjoying the process. But do get clear on who you are.

All traders though, need to be disciplined. This is an area that is probably the most difficult to manage should a trader be weak in this area, however our program will certainly show you how to fix that.

Revenue vs. Growth

The objective of a trader will also determine the style. Someone looking to create revenue or an income will have different needs to someone looking for capital growth. We must not get a growth trader mixed up with an investor. A growth trader may still be a very active trader but is simply compounding their profits for a longer term objective. The revenue trader on the other hand is looking to trade because they may want a steady income to provide for themselves.

A revenue trader is looking for short term price moves and can otherwise be known as intraday traders, swing traders, short term traders, range traders etc. A growth trader is looking for more medium to longer term trending moves, and can also be known as trend followers, medium term traders etc.

The major differences between the two is the number of opportunities taken per period (say a month or a year), and thus the time involved. Because more trades are taken by a revenue trader, it stands to reason that the average length of each trade will be shorter than those of a growth trader (with all else being equal such as trading capital).

Some of the key differences will be:

1. Time involved
2. Method used to enter and more importantly exit
3. Hardware and software requirements

More time will be required of a revenue trader, simply because they have more trades to take, based on the average length of each trade being shorter, and their need to achieve more consistent profits.

The method used to enter can be different for each type, but it is usually the exit strategy that differs the most. Revenue traders have a need for more consistent profits and this may mean that along with taking more trades, they will also need to exit trades on a more consistent basis. This can be done by using far tighter exit strategies and using profit targets. The growth trader on the other hand, has no need for profit targets or tight exit rules because they want to enjoy as much of the trend as possible; they’ll employ the use of wider exit strategies.

The revenue trader may also need to employ the use of more sophisticated hardware and software, also known as resources. This will of course depend heavily on the actual methods used, but shorter term traders who need to spend more time trading, may need higher internet speeds, up to the second price feeds, faster computers, more monitors, sophisticated charting software, and so on, where as the growth trader may only need to look at their trades for 10-15 minutes at the end of each day and feel that the charts provided by their broker (if they use an online broker) are more than sufficient, thus not requiring all these extra resources.

Move on to Step 2 - Module 2 > Objectives