Trading Concepts
There are many different types of traders, and one way to classify them is by the basic concept that they trade. Some concepts are diametrically opposed (e.g., trend following versus band trading), but you can trade any of them if you believe in it enough and practice low-risk ideas.
Trend Following.
The basic idea here is that you buy what’s clearly going up and sell it when it stops going
up. Similarly, you sell short what’s clearly going down and buy it back when it stops going down. The key to doing this is to have a method by which you define when to enter and exit that gives you low-risk trades
Fundamental Analysis.
The basic idea here is based on the supply-demand concept in economics. You need to analyze the market to find out where demand may exist and buy there (ideally, before it occurs). When
you think the price is high enough that demand may drop off, you sell. You could assume that when the supply is low, demand will increase and start the market moving, but that isn’t always the case. Let me give you an example in an area that I know well: rare U.S. stamps. Certain nineteenth-century stamps were issued in a very limited supply, and fewer than 100 are known to exist today. However, there isn’t much demand for these stamps, and so the prices are pretty reasonable. However, if just 50 collectors were willing to spend $100,000 on very rare U.S. nineteenth-century stamps, the prices would go up 10-fold or more.
Value Trading.
You buy things that are way undervalued, assuming that one day the market will catch up with their value. There are probably thousands of ways to value stocks, and some are more useful than
others. If you decide you like value trading, your job is to find one of the more useful methods.
Band Trading.
Certain instruments (stocks, commodities, and currencies) trade in bands. You buy something when it touches, crosses, or gets close to the lower band and sell it when it does the same thing for
the upper band. It doesn’t matter which order you do this in. The key to band trading is to understand how to develop useful bands.
Seasonal Tendencies.
Perhaps the real key to understanding seasonal tendencies is that what you find must have a fundamental basis for its existence. You can always use a computer to find meaningless correlations.
For instance, say you buy XYZ in the last week in March because it went up for the next three days in 18 of the last 20 years. That could easily be a statistical fluke. What you are looking for is something like this: The stock market tends to go up between November and May because pension money tends to pour into the market during that period.
Spreading.
This really gets into the realm of the professional traders who can create long and short
positions with a lot of potential to move but with a much lower risk profile. For example, you can buy a December option and short the March option. You can buy one currency and short another. These are common practices among professionals who can do large trades very cheaply.
Arbitrage (practiced primarily by professionals).
Here you find a loophole in the way things are done that gives you a huge edge. For example, before
currency trading was available, one of my clients discovered that he could buy sugar in London in
sterling and buy it in New York in dollars. He would spread the two markets to trade the dollar-sterling relationship, and he was the only one doing that. He said that in those days he’d have to unload one of his spreads if anyone wanted to trade sugar. Of course, this situation didn’t last too long because people figured out what he was doing, but while it lasted, he said, it was
like taking candy from a baby. The secret to arbitrage, of course, is to be able to find the loopholes and figure out how to capitalize on them
Intermarket Analysis.
Here we make the assumption that the price of one commodity (or product) is a function of what many other commodities are doing at the same time. It’s not just a simple relationship among
a few things. Thus, gold may be related to the price of oil, silver, the dollar, and a number of other currencies. These relationships change over time. Thus, the key to trading this concept is to evaluate a number of different inputs simultaneously to find the relationships that currently exist. Of course, this just lets you know the current relationship; you then have to use the key lowrisk concepts common to all systems to make money from the relationship.
There Is an Order to the Universe. Here there are a number of subconcepts, including
(1) waves of human emotion,
(2) physical events that may influence human behavior, and
(3) a mathematical order to the universe.
All these concepts can be traded if they fit you and you use the appropriate low-risk techniques.
All these concepts describe the setups that one might have for entry. Setups are a small part of trading, but because people think that picking the right investment is so important, these
types of concepts were developed. Trading styles actually arenamed after the setups.
