Trading strategies that work

I was talking to an old friend last week, who’s an extremely successful trader.

He was teasing me about my reliance on technical analysis. It’s a trading style that he has little time for – “witchcraft” he calls it!

So, what does he rely on?

He’s a bit of a mathematician at heart, and his trading is strongly based on statistics and probabilities.

And his style of trading works because he has an uncanny nose for sniffing out an “edge” …

The holy grail of trading strategies that work

Finding an “edge” is what trading is all about – it’s the difference between success and failure.

Whether you get that “edge” from an understanding of fundamentals … from technical analysis … or from a firm grasp of statistics and probabilities … it doesn’t matter.

Once you’ve got an edge, all you need to do is apply it again and again – and you’ll make money.

It needn’t be a substantial edge – just enough to get you ahead of the market and keep the odds in your favour.

And the beauty of an edge is that if you’re creaming a small profit from the market regularly, you’re likely to make considerably more money long-term than someone who’s pocketed one big win. (Euromillions winners excluded!)

So, how do we find that edge?

The most common ways in which traders find that edge are through:

Fundamental analysis: the study of external factors affecting supply and demand in the market. These are factors like economic events, trade prospects, political influences, government policies – even the weather.

Or technical analysis: the study of market prices themselves, assuming that market information is reflected in price, and that past price behaviour can give us clues about future price behaviour. In essence – it’s looking for patterns of behaviour, normally using charts and technical indicators.

Being more of a technical man – here are two ways I use to find that edge …

1. Trend following

The favourite way for traders to get an edge is by following a trend.

It’s simple – if the market is moving up, and you look for buying opportunities, you’ve naturally increased your chances of winning.

Likewise, if the market is moving down, and you stick with short trades, you’re improving your chances of success.

Trend following is great – but unfortunately, the market is not always moving in clear trends.

So, we need some more tricks up our sleeves.

2. Riding momentum

When you’re lacking a clear trend to follow, momentum provides another signal of market sentiment.

Momentum is simply the rate of change of a price, although it is often seen as a measure of volume – if prices are changing rapidly, it is likely that a lot of traders are buying or selling.

And, like trends, momentum can offer us a “free ride” in the direction of market sentiment.

There are a number of ways to measure momentum – the momentum indicator, rate of change, RSI, stochastics …. But there is a very simple sign you can look for – the size of the candle.

The length of a candlestick gives us a lot of information about the strength of market sentiment in one direction or another, so you can play momentum by simply following the direction of a long candlestick.

The technical stuff

Let’s say that if a candlestick was larger than the 10 previous candlesticks, we’ll open a position in the same direction as that movement …

This kind of trading is simply jumping on board moves and allowing that momentum to scalp you some profits.

The short trade you see on this example may or may not be triggered depending on how you gauge your candlestick’s length.

You might just look at the body – the difference between the open price and the close price. If this is the case, it would be a signal to trade.

However, many traders take into account the wicks on the candlesticks, and will view the lower wick as buying action, and the upper wick as selling action.

So, they’ll measure their candlesticks like this …

Riding these waves of market sentiment can be a great way to pick up points in the current market conditions, and with a few extra checks and balances to your momentum signals, you can filter out some of the false signals that will inevitably arise.

There are plenty more ideas coming up in the weeks ahead to keep us busy with our trading through the summer months …

Related posts:

Does technical analysis work? Momentum trading – a simple strategy to profit from momentum and trend