Friday, September 10, 2010

What kind of trader are you?

Traders falls into one of three categories:

Trend followers;
Counter-trend traders;

For the purposes of this article, we will look at the first two categories.

Trend followers usually wait for a trend to become apparent, and then 'hop on' and follow the trend, hence the name.

Counter-trend traders are usually entering trades in the same instruments at the same time, but in the OPPOSITE direction. This is as they feel that the move in the preceding direction is overdone, and are looking for a reversal. Or, in a non-trending market, they look to identify the floors and ceilings established in the instruments price movement.

Examples of counter-trend strategies include using oscillators such as RSI and stochastics, or by referring to pre-established support and resistance price levels.

Generally speaking, trend followers require wider stops to utilise their strategies, whereas counter-trend traders can normally use very tight stops and potentially increase their reward:risk ratio.

The pitfalls of both strategies are apparent - trend followers will erode their capital in a non-trending phase in the market, whereas trying to utilise a counter-trend strategy in a strongly trending market will result in repeated losses.

The timeframe used by the trader is also to be considered - generally speaking, people using very short time frames, such as intraday traders, will risk less per trade than someone using a good trend following strategy. I know of some day traders who risk less than 0.3% of their equity on each trade. In my own trading, I try to risk 2% of my equity per trade. Famed trend follower Ed Seykota, in his Market wizards interview, states that he 'intends to risk below 5% on a trade'.

A lot of the material avaiable on trend following systems refers to trading futures and commodities. It is perfectly useable however on stocks as well, which is where I concentrate my energies.

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