One trading strategy that involves equities is called ‘technical trading’. Find out if you have the right skills and personality to effectively be a technical trader.
In the financial industry, a term you will typically come across is ‘equity’. It is not unusual to refer to equity as shareholder equity, which also goes by the name ‘shareholders’ equity’. This is indicative of the amount of money that a company’s shareholders receive should all the assets be liquidated. Moreover, if all of the company’s debt were to be paid off.
There is a specific type of trading relating to this, which is ‘equity trading’. The standard equity trader is someone participating in the buying and selling of company shares on the equity market. This type of trader shares similarities with someone who invests in the debt capital markets. To elaborate, an equity trader invests in the equity capital markets and trades their money for company stocks rather than bonds.
There is an array of trading types that correlate with equity trading. Each is distinct in what they permit and what they provide traders. It is wise for beginners to experiment with each of these techniques. However, they should settle on what matches their investing knowledge and experience with a style that interests them. Specifically, one that is appealing enough to ensure further research and practice.
One of these techniques is ‘technical trading’. This is a trading discipline that gauges investments and identifies trading opportunities. While it would be easy to focus solely on this technique, this article will be covering something else. It will explore technical trading’s qualities to see if you yourself are a technical trader. To do this, we must also highlight the other trading types that connect to equity trading.
Trading type #1 – Technical
First and foremost, we will embellish the purpose of technical trading. As previously stated, this trading technique evaluates investments and pinpoints trading opportunities. It does so by analyzing statistical trends that stem from trading activity, including price movement and volume. Fundamental analysts (a trading technique that we will cover next) will make an attempt to gauge a security’s intrinsic value. Conversely, technical analysts focus on price movement patterns, trading signals, and other analytical charting tools to determine a security’s strength or weakness.
Generally speaking, technical trading is a much broader style; one that is not necessarily stuck within the confines of trading. A technician typically employs historical patterns of trading data in order to forecast potential occurrences to stocks in the future. This method is the same that economists and meteorologists practice. Specifically, looking to the past for insight on what will transpire in the future. With that in mind, forecasts have a tendency to be poor.
The primary challenge pertaining to technical analysis is that there are hundreds of technical indicators available. Moreover, there is no single indicator that is inherently better by universal standards. This is because each particular indicator, or group of indicators, may only be suitable for specific circumstances.
There are a select few technical indicators that may be useful for certain industries. Others are strictly for stocks of a certain classification. An example of this could stock within a specific range of liquidity or market capitalization. Due to the unique patterns that highly traded stocks exhibit, some indicators might solely be relevant to certain individual stocks.
Trading type #2 – Fundamental
Fundamental trading is a method in which traders concentrate on company-specific events. By doing this, they can determine which stock is the best to buy and when they should buy it. Trading on fundamentals has a closer association with a buy-and-hold strategy rather than the trading of the short-term variety. Be that as it may, there are specific instances where trading on fundamentals generates sizable profits in a short period.
A majority of equity investors are knowledgeable about the most common financial data that fundamental analysis uses. These often include earnings per share (EPS), revenue, and cash flow. These perceptible factors consist of figures that derive from a company’s earnings report, cash flow statement, or balance sheet. What’s more, they can include the results of financial ratios, like return-on-equity (ROE) and debt to equity (D/E).
Fundamental traders will typically employ such quantitative data as a means to identify trading opportunities. This is applicable if, for instance, a company distributes earnings results that consequently catch the market by surprise.
More often than not, fundamental traders concern themselves with obtaining information on speculative events that the market may be lacking. In order to remain one step ahead of the market, traders will sometimes employ the use of their knowledge of historical trading patterns. These patterns are ones that occur during the onset of stock splits, acquisitions, takeovers, and reorganizations.
There are two fundamental factors that traders and investors everywhere watch closely for earnings announcements and analyst upgrades and downgrades. However, acquiring an edge on this information is quite difficult. This is because there are millions of eyes on Wall Street on the lookout for that very same advantage.
Trading type #3 – Scalping
Scalpers are individuals that enter and exit the financial markets very quickly; often within seconds. They utilize higher levels of leverage as a means to place larger trades. They do this in the hope that they will achieve greater profits from comparatively small price changes. In the context of market supply-demand, a scalper refers to a person who purchases large quantities of in-demand items. Such items include new electronic devices or event tickets. They buy them at regular price, hoping that the items will sell out. Afterward, they will resell the items at a much higher price.
A recognizable example is a scalper purchasing 10 Super Bowl tickets. After purchasing them, they will try to sell them on eBay just mere days before the game at a higher price. These kinds of transactions will often take place on the black market, hence the illegality of this particular case.
Scalpers will buy and sell multiple times in a single day. Their goal is to make steady profits from accumulative movements in the traded security’s price. They will either trade manually or automate their strategies by utilizing trading software.
The outcome of high-frequency trading is effectively making a scalper’s job more competitive. Programs can comb through thousands of securities at once and benefit from divergences between the bid and ask in milliseconds. Black box algorithms also oversee level 2 data, analyzing price and liquidity information in order to conduct short-term trades.
Scalpers will typically use the one-minute and five-minute charts to settle their trading decisions. Sometimes, they will purchase intraday scanning software as a way to discover new opportunities. A substantial amount of scalpers engage in high volume trading. What’s more, they use online brokers who offer competitive commissions to keep their trading costs low.
Trading type #4 – Momentum
Momentum trading is a technique that entails traders buying and selling in accordance with the strength of recent price trends. Price momentum shares similarities with momentum in physics. To elaborate, it’s where mass, when multiplied by velocity, determines the probability that an object will continue on its path.
When it comes to financial markets, one determines momentum by way of other factors. These will often include components like trading volume and the rate of price changes. Momentum traders wager that an asset price moving strongly in a given direction will keep moving in that direction. They bet that it will proceed to do this until the trend loses strength.
Momentum trading is a technique that is not for everyone. What that said, if executed properly, it is possible for you to receive impressive returns. There is a crucial requirement for severe discipline to effectively trade in this type of style. This is largely due to the trades needing to close at the first sign of weakness. Moreover, the immediate placement of the funds must be in a different trade that flaunts strength.
Factors, such as commissions, are what make this particular type of trading impractical for many traders. However, this story is gradually starting to change. This is possible thanks to low-cost brokers taking on more influential roles in the trading careers of short-term active traders. Buying high and selling even higher is the desirable goal of momentum traders everywhere. Be that as it may, this objective is not without its fair share of challenges.
Trading type #5 – Swing
Swing trading is a trading technique that tries to capture gains within a stock over a certain period of time. This can range from a few days to several weeks. Other than stocks, it can also be any kind of financial instrument. Swing traders will primarily employ the use of technical analysis when it comes to looking for trading opportunities. These particular traders may use fundamental analysis in addition to examining price trends and patterns.
Swing trading usually involves maintaining a position either long or short for more than one trading session. However, its duration is typically no longer than several weeks or a couple of months. This is mostly a general time frame, as some trades will sometimes last much longer than a couple of months. Still, the trader might still see them as swing trades.
The primary objective of swing trading is to acquire a chunk of a potential price move. There are some traders who actively seek out volatile stocks with lots of movement. Others will often prefer more unflappable stocks. Whichever the case may be, swing trading is the process of pinpointing where an asset’s price will likely move to next. From there, there is an entrance into a position and then capturing a chunk of the profit from that move.
Swing traders will mainly use technical analysis, which is mostly because of the short-term nature of the trades. Be that as it may, fundamental analysis can be useful for strengthening the analysis. Let’s say for example that a swing trader sees a bullish setup in a stock. In this case, they may want to validate the favourability of the fundamentals of the asset. Alternatively, the fundamentals are improving.
Day vs. Swing
Before we move forward, we should clarify the difference between swing trading and day trading. The chief distinction between the two is the holding time for positions. Swing trading will involve a hold that lasts overnight. On the other hand, day traders close out positions prior to the closure of the market. Day trading positions have a single day limitation, whereas swing trading involves holding for several days or even weeks.
By holding overnight, the swing trader will provoke the unpredictability of overnight risks. These include such things as gaps up or down against the position. When taking on the overnight risk, swing trades will usually be conducted with a smaller position size. This size is noticeably smaller when you compare it to that of day trading (assuming the traders have similar accounts regarding size).
Day traders customarily utilize larger position sizes and additionally, they may use day trading margin of 25%. Swing traders will also have access to margin or leverage of 50%. What does this mean? Well, let’s assume that the trader garners approval for margin trading. In this case, for example, they only have to put up $25,000 in capital for a trade with a value of $50,000.
Common indicator groups
Technical indicators are calculations that are heuristic or mathematical. They draw from the price, volume, or open interest of a security (or contract) that traders following technical analysis use. Technical analysts or chartists actively seek out technical indicators in historical asset price data. They do this so that they can evaluate entry and exit points for trades.
There are five prevalent groups of technical indicators. They are the Relative Strength Index, Range Trading, Pattern Analysis, Trend Analysis, and Gap Analysis.
1 – Relative Strength Index
The relative strength index (RSI) is a momentum indicator whose purpose is to measure the magnitude of recent price changes. Doing so will allow them to evaluate overbought or oversold conditions in the price of a stock or other asset. The RSI will often register as an oscillator and can have a reading ranging from 0 to 100. For context, an oscillator is a line graph that moves between two extremes.
This indicator measures a stock’s recent performance regarding its historical strength. This is possible by way of comparing the number and the magnitude of recent and historical up and down closes. Should the RSI rise above 80, then this indicates an overbought condition, which is a sell signal. If it is below 20, then this indicates an oversold stock, which is a buy signal.
The RSI compares bullish and bearish price momentum and exhibits the results in an oscillator. This can be placed alongside a price chart. Similar to most technical indicators, its signals are most trustworthy whenever they harmonize with the long-term trend.
True reversal signals are quite rare and are often difficult to separate from false alarms. For instance, a false positive would be a bullish crossover, with a sudden decline in a stock following. A false negative would be a situation in which there is a bearish crossover, but the stock experiences an upward acceleration.
2 – Range Trading
Range trading is a strategy that involves a trader identifying overbought and oversold areas, otherwise known as support and resistance areas. They then purchase at the oversold area (support) and sell at the overbought area (resistance). This strategy works especially well in markets that are drifting up and down with little to no discernible long-term trend. Conversely, the strategy is not as effective in a trending market. However, it can be useful if one takes the market’s directional bias into account.
A series of high, low, and closing prices are put on a graph and plotted for a specific period of time. Afterwards, the support and resistance lines are drawn across the bottom and top of the range. A breakout will occur when the price maintains a consistent movement. This is regardless if it is for a period or two and above or below the range.
3 – Pattern Analysis
Out of all the forms of technical analysis, this is the one that is arguably the easiest to understand. The same price charts that were discussed earlier undergo analyzation for specific patterns. These are patterns that have made past appearances in the same stock. Alternatively, they are subject to examination for common patterns that are recurring in many stocks over time. The patterns with the most observations are the following (among others):
- Head-and-shoulders patterns
- Triangle-up or triangle-down patterns
- Rounded tops or rounded bottoms
- Cup-and-handle formation
4 – Trend Analysis
Trend analysis is a technical analysis method that seeks to forecast future stock price movements. It does so by drawing from the observations of recent trend data. Trend analysis itself stems from the idea that what occurs in the past gives traders an idea of future happenings. There are three main types of trends, each one of them being terms: short-term, intermediate-term, and long-term.
The main objective of trend analysis is to try and predict a trend, such as a bull market run. Once it detects a trend, it rides it until the data implies a trend reversal, such as a bull-to-bear market. Trend analysis is greatly beneficial because moving with trends – not against them – will result in profit for an investor.
Mathematical trend analysis with high complexity looks at short and long-term trends and tries to identify crossovers. This is the point where prices cross over their long-term averages. The long-term averages are otherwise known as ‘moving averages’. This is where, for a period of time, a price range is smoothed. To do this, a series of data points is averaged. Then there is the plotting of the smoothed line against the stock’s actual price line.
The moving average convergence divergence (MACD) helps identify crossovers, divergence, and convergence. Moreover, it establishes conditions that are overbought and oversold.
5 – Gap Analysis
Gap analysis is a procedure that companies frequently use. It allows them to examine their current performance with the performance that they desire. This analysis is especially useful for determining whether or not it is meeting expectations and effectively using its resources effectively.
Gap analysis is the means by which a company is able to recognize its current state by way of measuring various factors. These measurable factors are time, money, and labor. From here, they can compare it to its target state. By properly defining and analyzing these gaps, the management team can create an action plan. This plan will allow them to move the organization forward and fill in any gaps in the performance.
A gap ensues whenever a stock’s opening price is significantly higher or lower than its closing price the previous day. This is possibly due to the overnight release of company news or perhaps some other factor. The concerns of a gap trader are mainly with the performance of the stock above or below its open. This may be indicative of additional movement in either direction. In this sense, the trader’s decisions are probably closer style-wise to the momentum trader than the technical analyst.
This particular type of analysis also goes by the name of ‘needs analysis’. Overall, it is a crucial process for any type of organizational performance. It allows companies to determine where they are in the present and where they hope to be in the future. Companies are able to reconsider their goals through gap analysis to figure out if they are on the right track.
Now, with the embellishment of each trading method, you should now be able to determine if you’re a technical trader.
If you want to learn more about technical trading/analysis, there are two other articles to check out. One is “A Guide to Technical Analysis: Differences between Fundamental Vs. Technical” and the other is “What is Technical Analysis?”