Trading Strategies –The 3-Elements Concept
Applying a strategy is ‘everything’ when you trade the global financial markets. The implementation of the right trading strategy is what really distinguishes winners from losers in the long-run.
“Trading Luck suddenly ends and there starts a Trading Strategy”
Applying a strategy when you are trading means building a system of knowing always what you must do next. If you want to evolve into a profitable trader these are the three elements you must incorporate into every trading decision, these 3 elements together form a complete trading strategy.
The 3 Elements of a Trading Strategy
A Trading Strategy has 3 main elements:
1st Element: Asset Allocation / Trend Identification
The first element involves the process of selecting the right asset to trade by knowing also if you should go Long (buy) or Short (sell) the market. The trend evaluation procedure must be always in accordance with the timeframe you trade. If you are a day trader there is no point of trying to evaluate a long-term trend.
Alternatively, you can use this definition for determining the trend in any timeframe:
□ Rising Trend: A Trend is rising when a local High is higher than the previous High and at the same time the recent Low is Higher than the previous Low.
□ Falling Trend: A Trend is falling when a Local Low is lower than the previous Low and at the same time the recent High was lower than the previous High.
2nd Element: Trading Signals and Timing
After the asset allocation/trend evaluation process, the 2nd element involves the selection of time that you should trade. That means the time to buy or to sell the previously allocated financial asset. At this point, you must use an additional indicator capable of confirming the trend and capable of providing trading signals. A trading signal indicates the entry and exit levels of a potential trade.
Trading Forex and Fundamental Analysis
The fundamental analysis aims to predict the future market conditions based on the study of current economic indicators and other fundamental data.
The Important Role of Central Banks
Central Banks play a key role in the Foreign Exchange Market, more specifically:
They are applying the monetary policy by modifying interest rates
They help governments to implement their fiscal policy objectives
They are responsible for controlling the domestic banking sector
Central banks have the ability to adjust the level of interest rates at any given time. Therefore, they can control the demand for the domestic currency and the exchange rate of the domestic currency against foreign currencies.
“Trading against the Central Bank policies is madness unless your name is George Soros.”
8 Major Categories of Fundamental Data
These are the eight (8) categories of fundamental data that are highly affecting the Forex markets.
High Frequency Trading (or HFT) in general is part of the electronic trading. This type of trading uses complex algorithms to analyze and to evaluate multiple markets simultaneously. Based on the market conditions High Frequency Trading systems are executing tens of orders in a matter of seconds.
The High-Frequency Trading Domination in the US
High-Frequency trading systems open and close positions in a fraction of a second and form the million-second markets. These Fast-Markets are extremely liquid and can highly influence all real Equity Markets. It is estimated that 50% of the total US stock-trading volume is driven by computer-based high frequency trading systems. Others believe that today the activity of HFT exceeds 65% of the total US stocks activity. High Frequency Trading has become very popular nowadays. There are hundreds of new start-up companies worldwide focusing exclusively on exploiting opportunities deriving from this lucrative market. Only in the US the High Frequency Trading industry is estimated to worth about 300 billion USD. In overall, there are more than 20,000 firms in the US that are specialized in high-past computerized programs for trading stocks. The most important players in the HFT industry according to the Deutsche Bank are:
i) Multi-Service Firms: Citigroup and Goldman Sachs
ii) Hedge-Funds: Citadel and Renaissance Technologies
iii) Trading Firms: Getco, Optiver and Tradebot
Why HFT makes Investors and Regulators Skeptical?
In May, 6th 2010 the Dow Jones Industrial plunged 600 points in just five minutes. This is the so-called "Flash Crash" of 2010. The DJIA after the 400-point drop was able to recover within 20 minutes and closed the day about 3.0% down. High Frequency Trading held responsible for this abnormal DJIA behavior and since then HFT made everyone skeptical about the future.
High-Frequency Trading Strategies
Here are the main high-frequency trading strategies:
1) Market Making Strategy
This is the simplest way to profit from high-frequency trading. Market making strategy involves placing 2 controversial trades (bid and ask) in order to profit from the bid-ask spread.
2) Low-Latency Arbitrage
This trading strategy relies on low latency technology. The ability of trading fast can lead to the exploitation of price inefficiencies when the same security is traded simultaneously on two disparate markets.
3) News-Trading Strategies
This is a very popular method of speculation. Macroeconomic or company news create a predictable row of fluctuations. HFT systems given the right configuration can process and trade the news faster than individual human traders.
4) Event Arbitrage
This strategy aims to exploit predictable short-term fluctuations after important events.
5) Statistical Arbitrage
The statistical arbitrage strategies are designed to take advantage of temporary deviations from important historic statistical relationships among certain financial assets.
Currency Carry Trade Strategy
In general, carry trade means borrowing money at a low interest rate and investing in assets with higher returns.
Currency Carry Trade
Currency Carry Trade is a strategy that involves selling a currency offering a relatively low-interest rate and at the same time buying a currency offering a relative high-interest rate. The goal of Forex carry traders is to capture the interest rate differential between two currencies which can be substantial, depending on the rate of capital leverage they use.
Usually, currency investors are borrowing money in Japanese yen or Swiss francs which are two currencies offering traditionally very low-interest rates, close to zero. They use this money they borrowed for opening long positions in currencies backed by high-interest rates, such as the Canadian Dollar, the New Zealand Dollar and the Australian Dollar.