After several years of trading, active investors tend to narrow their approach to trading. Some folks are pure day traders that prefer to be back to a 100% cash position by the end of the day, others only trade options exclusively, many choose only to buy names that have the highest relative strength readings, while others yet lean towards value and dividend plays. Some rely on charts without even taking a look at the company or what they do, others dig deep for mispriced securities with strong fundamentals, and a lot of folks like to use a combination of the two. Of course, these are just a few of the myriad of ways to approach the market, and the trick is to figure out which one works best for you.
At the end of the day, no one trading style is inherently better than any other, and all of them can help an active investor produce superior results. But, a system or approach that works great for one trader may not work so well for another (and vice versa). The key, then, is the individual themselves and their ability to implement and adhere to an effective methodology in the right vehicles. No matter what the approach, if you’re executing well then the strong likelihood is that you will outperform someone with a different style who doesn’t execute as well.
Accordingly, figuring out which style is best requires that you know yourself, your timeframes, the amount of time that you can devote to implementing a strategy, and how you think about the market in general. There are many different ways to view market movement and to be effective it has to have some sort of logic that you can appreciate and embrace.
From there, the most important part of any trading style is that you have a clear plan. You need to know ahead of time the actions you plan on taking depending on various scenarios taking shape. It’s nice to think about what you’ll do if things work, but you have to be especially prepared to take action if things go wrong. At what point do you lock in gains and, more importantly, at what point do you cut a trade that isn’t working? Every style has to gameplan all the different ways a trade will play out, and those premeditated bobs and weaves will likely be different depending on your approach.
For instance, trend traders view weakness beyond a certain point as a major warning sign, but for someone with a fundamental approach, weakness is an opportunity… assuming, of course, that there haven’t been any changes in the company’s prospects. In other words, you have to be clear about the theoretical underpinnings of various approaches. Momentum players are basically banking on the idea that stocks that are trending upward are being discovered by more and more buyers who realize the great potential. Even if the fundamentals aren’t necessarily there, they believe that the market is correct and the pricing action will tell you when that changes.
Dip buyers and value players tend to look for situations where they believe the market is wrong. They want to buy stocks that are being sold because the market is mispricing them (or looking in other areas) and doesn’t really understand the long-term picture.
One last observation is that no investor should ever become so engrained with a style or approach that they won’t recognize when it’s time to make some adjustments. The effectiveness of a trading style will vary greatly in different markets. There are times when a buy-and-hold type approach works best and there are other times when very aggressive trading works better.
Like a trading plan, the most important aspect of an investment style is that you have on in the first place. It’s remarkably easy to drift from your core set of rules because of an emotional reaction to every twist and turn. You may have some good results at times but ultimately an organized and disciplined style will keep you out of trouble and produce better results.
