Stock Trading Strategies

Let’s look at each strategy briefly.

Contrarian Trading Strategy

Contrarian traders try to do the opposite of what other people are doing. When everyone is excited about a stock and buying it, they will sell it. And when people are bored by an investment and want nothing to do with it, they will buy it. Often these people will charmingly remind you that sheep get slaughtered.

Trend Trading Strategy

Trend traders take an opposite approach to trading compared to contrarians. They buy on the up swing and sell on the down swing. This strategy requires careful monitoring of the market and frequent buying and selling which can increase trading costs. Trend trading is an easy strategy that requires little research. You just have to know if the asset is going up or down and join the party.

Social Trading Strategy

Social traders buy and sell on news from peers. For instance they act on “hot tips”, news, commentary, recommendations. It’s possible for social traders to act as contrarian or trend traders depending on who they listen too. They don’t necessarily act as one of the two though.

Technical Trading Strategy

Technical traders look for patterns in a stock’s price data. They use these patterns to forecast future prices. Technical traders are often interested in break points or price floors. Break points and price floors are significant price levels. If a stock passes a break point it is considered to have entered into a new, higher, trading range and if a stock falls below a price floor it is considered to be in a new, lower, trading range.

Testing Strategies’ Performance

If you want to evaluate these different strategies it’s useful to use old data and consider what each strategy would have recommended it and then check this result to the actual result. The strategy with the lowest error is the best performer.

Random Traders

It can be useful to include a control strategy such as a Random Trader when testing trading strategies. Random traders buy and sell stocks randomly. They make a good control group and are useful for showing that “experts” do not always perform better than a random trader. If you’ve ever read a newspaper article where top stock pickers compete against each other they often include a random trader (sometimes called the monkey). The monkey sometimes does better than the experts (who are quite clever but not quite clever enough) and the newspaper can delight in pointing this out.

Final Word

I always like the random traders because they show that it’s not possible to tell if an expert is skilled or just lucky. Similarly don’t put too much faith in any one strategy or consider any investment in a risky asset a sure thing. When trading anything can happen, that’s what makes it exciting!