What is a 'Trading Strategy'

A set of objective rules defining the conditions that must be met for a trade entry and exit to occur. Trading strategies include specifications for trade entries, including trade filters and triggers, as well as rules for trade exits, money management, timeframes, order types, and other relevant information. A trading strategy, if based on quantifiably specifications, can be analyzed based on historical data to project future performance.

BREAKING DOWN 'Trading Strategy'

A trading strategy outlines the specifications for making trades, including rules for trade entries, trade exits, and money management. When properly researched and executed, a trading strategy can provide a mathematical expectation for the specified rules, which helps trades and investors determine if a trading idea is potentially profitable. Investors should generally consider using a systemized trading strategy, but be aware of its many limitations. Trading strategies aren’t a guarantee for success, but they may be effective in increasing risk-adjusted returns.

Pros and Cons of a Trading Strategy

Trading strategies are a great way to avoid behavioral finance biases and ensure consistent results over time. For example, traders with a specific set of rules governing when to exit a trade will be less likely to succumb to the disposition effect, which causes investors to hold on to stocks that have lost value and sell those that rise in value. Trading strategies can also be stress tested under many different market conditions to ensure consistency.

The downside is that profitable trading strategies are difficult to develop and it’s easy to become overly reliant on the strategy. For instance, a trader may curve fit a trading strategy to specific back testing data, which can generate a false sense of confidence. The strategy may have performed great based on the past data, but that’s no guarantee that it will perform just as well using live market data since the conditions may be different.

Developing a Trading Strategy

There are many different types of trading strategies for investors and traders to consider, but they can be generally broken down into technical and fundamental trading strategies. The common thread between these two types of strategies is that they both rely on quantifiable information that can be back tested for accuracy.

Technical trading strategies rely on technical indicators to generate trading signals. For example, a simple trading strategy may be a moving average crossover whereby a short-term moving average crosses above or below a long-term moving average.

Fundamental trading strategies take fundamental factors into account. For instance, an investor may have a specific set of screening criteria to generate a list of opportunities. These criteria may look at things like revenue growth or profitability.

Investors and traders should find the strategy that works best for them through experimentation, back testing, and paper trading. For more, see How to Practice Day Trading. 

 

RELATED TERMS
  1. Forex Trading Strategy

    A forex trading strategy is a set of analyses that a forex day ...
  2. Exit Strategy

    An exit strategy is the method by which a venture capitalist ...
  3. Active Trading

    Active trading is the buying and selling of securities with the ...
  4. Trend Trading

    Trend trading is a trading strategy that attempts to capture ...
  5. Entry Point

    Entry point is the price at which an investor buys an investment.
  6. Balanced Investment Strategy

    A balanced investment strategy is a method of portfolio allocation ...
Related Articles
  1. Trading

    Using Technical Indicators To Develop Trading Strategies

    Unfortunately, there is no perfect investment strategy that will guarantee success, but you can find the indicators and strategies that will work best for your position.
  2. Trading

    Create Your Own Trading Strategies

    Do-it-yourself trading can be very rewarding—both psychologically and for your wallet.
  3. Trading

    Day trading strategies for beginners

    This day trading tutorial covers general principles, deciding when to buy and sell, common day trading strategies and how to limit losses.
  4. Trading

    4 common active trading strategies

    Learn four of the most popular active trading strategies — and why active trading isn't limited to professional traders anymore.
  5. Trading

    Technical Analysis Strategies for Beginners

    Technical analysis helps traders and investors navigate the gap between intrinsic value and market price by leveraging certain techniques.
  6. Trading

    Adjusting Day Trading Strategies For Different Market Conditions

    Being a successful trader means knowing when to play the market and how. Find out what strategies will have you on top.
  7. Investing

    What Type of Trader Are You?

    There are different trading strategies that investors use to profit from market movements. Which of these strategies for buying and selling do you use?
  8. Trading

    Pinpoint Entry Points With Filters and Triggers

    These tools will help you enter at high-probability points within your set strategy.
  9. Trading

    Effective Risk Control With Scaling Trading Strategies

    Scaling strategies allow for greater risk control than simple entries or exits, letting traders seek the most advantageous prices available.
RELATED FAQS
  1. What are common trading strategies used in a bull market?

    Discover four commonly used trading strategies by investors and analysts to make profits from a prolonged bull market, including ... Read Answer >>
  2. What Does It Mean When There Is 'Price Action'?

    Price action refers to the day-to-day fluctuation in the price of an asset. Read Answer >>
Hot Definitions
  1. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  2. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  3. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
Trading Center