Markets are brutal. It’s a zero-sum game by design – the success of one trader means failure of others. In order to survive and thrive in such conditions your personal approach to the market must not only be superior than others but also complement your personal style.

The best thing about markets is that there is no rule book. Every single trader views markets differently and builds up his own trading system. These systems can be based on different approaches to the market such as investing, trend following, swing trading and day trading.

These approaches define when you buy and sell an asset and these definitions influence the frequency of trades and levels of required attention to the market.

But the question is – how can you identify which style suits you? Each style presents its own challenges and you need to know yourself to make the right choice.

Investing

Investing is a passive approach, which requires a big chunk of time to study and understand the markets and almost no time after execution of the trades. It is a long-term commitment and helps to build wealth gradually over an extended period of time. The main idea is based on buying an underappreciated asset and selling it when it hits a fair price. Process of getting to the fair price might take from months to several years.

Investing is popular because it doesn’t require a lot of attention to the market and an average investor might earn more than an average trader even if he puts in many less hours of work.

This style comes with some requirements:

  • Money. It doesn’t make sense to invest a $100 to earn $200 in a year. If you are not wealthy then there are better options than investing
  • Fundamental knowledge of the market
  • Ability to adapt to the fundamental changes
  • Presence of patience

The worst part of investing is that you won’t know if you made the right choice for a very long time. Being wrong is painful and costly, because the result is usually all (if your fundamental analysis worked out) or nothing.

If your investment failed it’s pretty hard to learn from this experience because every asset is somewhat unique. Understanding the reason of failure might not help in making better decisions next time.

But on the bright side investment provides great opportunities for almost everyone. Fundamental analysis is very subjective and there is a good chance that you will find an underappreciated asset just because of your personal approach of evaluating the markets


Trend Following

Trend following is a more active approach. It relies on the fact that if an asset is trending (upwards or downwards) then chances are that it will continue to stay in that same trend. Followers of this style enter the position when the market signals a confirmation of the trend and exit the position when the market signals a trend exhaustion or reversal. Some approaches imply constant involvement in the market and instead of closing positions, a trader often opens a new one in the opposing direction. Duration of the trade varies based on the power of the trend and chosen timeframe.

Technical analysis defines strict rules of trend following. These rules are pretty hard to follow and that’s why trend following is not as popular (even though it can be very profitable in the long term). 

The main idea of trend following is based on buying an asset when there is a sign of a global trend reversal (for example a breakthrough of the local high price) and if the trend confirms – adding to the position (averaging up) and riding it all the way until the trend exhaustion.

Why is trend following considered to be hard?

Let’s take a look at the example:

This is a chart of ETC relative to BTC with the addition of and exponential moving average (EMA) as a tool which helps to determine the trend. The main trade idea in this scenario is: the price below the EMA indicates a bearish trend, while above EMA indicates bullish momentum.

The strategy is very straightforward: buy the asset once price closes above the EMA, and sell when it breaks below the EMA. If price is above the EMA, then consider entering big positions on the dips. The problem is that this strategy doesn’t account for sideways action which might take a long time. Circles on the chart above show entry points. Green circles represents profitable entries, while red circles represents a loss. 

Let’s take a closer look.

We can clearly see that the price was sideways on this chart with not much action. Our strategy requires us to take action on each break of the EMA as if it was a beginning of the new trend. We had 3 unsuccessful attempts before real trend establishment and we would take 3 consecutive losses before the real trend. Ouch! Without proper position sizing it would hurt a lot.

The twist of the strategy is that we use low position sizes as our first “try” to feel the trend so if it goes south we don’t lose much. But once the trend establishes we go in size on each price dip until it doesn’t work. We finally exit the trade on the break down of the EMA.

Right now there is a pattern similar to the previous sideways action. Buying ETC using a trend-following strategy in the last 6 months wouldn’t produce a lot of profit. There were 3 failed attempts before a tiny trend. Does it mean that a strategy doesn’t work anymore? Of course not! It means that currently there is no trend so there is no money to be made and we are just looking to reduce our losses on the unsuccessful attempts.

Results of ETC trend following over the last 2 years.

For each confirmed trend (even if it was a small one) there were usually 3 or 4 fakeouts. It means that this simple trend following strategy has ~25% winrate. How does one make profit with such a strategy?

The first step is to select a proper tool for trend following. Simple EMA doesn’t work very well because it eats a lot of profits during the sideways action. I prefer such tools as Ichimoku Cloud and RSI.

The second step is to be conservative on your first entry of the trend. When you are placing an order, you need to be sure that you understand that this attempt will most likely fail (after all, our strategy has a 25% winrate). Once you understand that you will definitely place smaller orders.

The third step is to trust the established trend and buying in size on the price dips. This strategy makes money not from getting a huge gain on the single order but on lesser gains on several bigger orders.

So what is so hard about this approach?

Any strategy requires consistent execution of its rules. Following rules of this strategy is uncomfortably hard from a psychological perspective because of the low win-rate. At some point you might think that a strategy is not working anymore and you can’t afford to make this mistake. Trends are rare and if you miss one after several unsuccessful attempts because of personal bias about the strategy it will be even harder to make consistent profit.

Requirements of trend following:

  • Capital of an average size
  • Knowledge of basic technical analysis (TA) tools
  • Time spent is based on the amount of markets you can monitor at least on a weekly basis
  • Ability to accept the fact that most of the trades are losers and to believe in the profitability of the system
  • Discipline
  • Basic knowledge of risk management 

 


Swing Trading

Swing trading is a style which attempts to capture gains within a relatively short period of time (from a couple of days to several weeks) using short-term price momentum.

Most of the swing trading strategies are heavy on technical analysis, but there is a fundamental approach as well.

Good examples of fundamental momentum shifts are airdrops and forks.

Here is the infamous ZCL-BTCP airdrop which caused a huge spike up in price over several weeks. Obviously such a growth was unsustainable and ZCL faced a precipitous drawdown afterwards.

While a fundamental investor may see value in the airdropped coin and buy ZCL solely to own a new asset, the swing trader sees value only in the rapid momentum change pre-fork which causes massive spikes up. It’s the swing trader’s job to understand market sentiment, buy the coin in anticipation of the momentum and sell at its climax pre-fork. He doesn’t care if the airdropped coin is good enough to become part of his portfolio, he is here to take fast profits based on the current hype. One of the biggest possible mistakes is to start a trade as a swing trader but get mixed up in the FOMO and end up as an investor. It’s a recipe for disaster!

Even though fundamental momentum shifts exist, usually swing traders use technical analysis to spot them. Technical analysis is a trading tool which identifies trading opportunities by analyzing price behavior from the past. It is based on the idea that price creates recognizable patterns which have higher chance of unfolding in certain way.

Now let’s check a live example.

Here is the chart of ONT relative to BTC. Price is in a steady uptrend, but still forms some recognizable patterns you’ve seen on the scheme above. The trend starts with a solid double-bottom formation and then there are several flag-shaped consolidations on the way up. It’s important to understand that patterns don’t have a 100% chance of unfolding in a certain way – rather, they give a small edge which might increase based on the current market sentiment. For example, a flag breakout in the red circle failed because of the small correction in the whole crypto market, but the trend ultimately remained intact.

There are other tools such as different types of candles, volume, trend identification indicators, momentum indicators, oscillators and much more. Every trader has the tools to build his or her own trading system.

Requirements of swing trading:

  • Capital of any size
  • Deep knowledge of technical analysis tools
  • Tons of time (depends on your timeframe)
  • Ability to work hard on development and testing of strategies before entering the market
  • Discipline to execute chosen strategy and not to shift to investor mentality if trade doesn’t go the right way
  • Risk tolerance and basic knowledge of risk management

Day Trading

Day trading is the most active approach which requires ongoing participation in the market. Trades are executed within one day and are directed at catching small inefficiencies in the market. Positions are opened only when you have direct access to the market.

Картинки по запросу day trading

There are two styles of day trading: arbitrage and market making.

Arbitrage is the simultaneous purchase and sale of the same asset to profit from an imbalance of the price on the different exchanges. It exists as a result of market inefficiencies, which means traders using this approach make markets more efficient.

The problem with arbitrage is that it’s impossible to manually monitor all the pairs on different markets. Humans certainly weren’t made for this type of work. Computers on the other hand are great abusers of this arbitrage technique. They can simultaneously monitor all the markets and make orders in a matter of milliseconds.

Another style – market making is based on providing liquidity to the market by filling order books with both buy and sell orders. Since markets are inefficient there are strategies to place orders based on the structure of the order book which in the long-term make steady profit. These strategies are also known as High Frequency Trading.

The problem remains the same – the computer will do the job much better than any experienced trader.

You could also argue that swing trading on the low timeframes counts as a day trading, since these chart patterns are evident on all timeframes. But remember that the lesser the timeframe is the less reliable chart patterns are. Swing trading on the low timeframes increases your risk but lowers your reward since moves are much smaller.

Bear in mind, in order to make substantial gains from the small price movement you need to either have big capital or to use leverage, which increases risk even further.

Requirements of day trading:

  • Big capital or increased risk
  • Deep knowledge of technical analysis OR algorithmic trading
  • Tons of time OR working bot
  • Ability to work hard on development and testing of strategies before entering the market
  • Discipline to execute chosen strategy
  • Risk tolerance and basic knowledge of risk management

So what to choose?

To choose a correct approach you need to be completely honest with yourself. Be aware of your capabilities – especially in time, money and discipline.

If you have a work and two kids at home, don’t even dream of becoming a day trader or a swing trader. You may have discipline to execute trades according to the plan but the lack of free time will have a direct impact on your performance. What if you don’t have enough money to invest or follow the trends? Chances are that you will make much more profit taking some extra work shifts and building your capital this way.

What if you have a lot of capital? It depends on your personal preference between fundamental and technical analysis. Investing is always a good option because deep pockets allow you to be much more flexible with your purchases. Discipline is the most important factor in performance of technical analysis trader and if you don’t feel like overcoming yourself on the daily basis then it’s not for you. If you still think that you are capable of following TA strategies then trend following or swing trading makes most sense.

What if you have a lot of free time but don’t have any capital? Take the risks, learn technical analysis and try out swing trading on medium timeframes. It can be somewhat risky, but you don’t have a lot to lose anyway. It also gives the best chances to quickly build up your capital and then pivot to a more conservative approach down the road.

It’s important to mention that these styles work only if you set strict rules for your actions. You can’t enter the trade as an investor and exit as a swing trader or vice versa. Build your system from scratch and then follow it as if it is the Holy Bible. Be patient and disciplined and profits will come!