Trading Styles Explained: Pros and Cons of Each Approach
Having your trading style means having a clearly defined investment and risk strategy.
Over time, traders develop their own investment approach. This is a very individual decision resulting from experience, decision-making approach, psychological profile, etc.
There are as many trading styles as traders. However, we can draw up a conditional categorization. On the one hand, there is a way of making an investment decision (e.g., technical or fundamental). On the other hand, there is a time frame (a day or year) for holding open positions.
Scalping
This trading style attempts to profit from a high number of short-term trades. Trading positions are closed within seconds or minutes. Some aggressive traders make dozens or even hundreds of trades a day. Many small profits must offset losses and trading costs. The strategy implies the usage of significant leverage since the price target and stop orders are closely placed (a few pips).
“Scalping” follows clear rules for position management, usually based on technical analysis (chart patterns, indicators).
These strategies are often applied during periods of increased volatility when price changes are significant. However, high volatility creates a high risk, which some scalping sub-strategies intentionally avoid.
Scalpers increase or reduce their exposure under certain circumstances. For example, when a position moves in their favor by a pip, they double the position size. In other scenarios, they will reduce exposure. It is common to go from a long position to a short one within seconds. So, scalping trading is highly dynamic by its nature.
The bid/ask spread cost, which can accumulate quickly given the high number of transactions, must be considered when scalping. In a volatile market, this spread usually widens. The technical execution of the order also presents a challenge: market orders don’t guarantee execution price.
For these reasons, scalpers trade mainly in highly liquid currency pairs such as EURUSD when the US and European sessions are open (the most liquid period of the day). Choosing a broker that quotes attractive spreads (usually ECN brokers) is crucial for these strategies.
Nowadays, scalping is increasingly executed automatically – by trading algorithms. Thus, the emotional side of trading and the risk of technical errors are significantly reduced.
Day Trading
“Day trader” defines a time slot rather than a trading style. This strategy is like scalping in many ways. Trades are fewer in number but often amount to several per day. Positions are held open longer but do not remain open overnight.
The short-term nature of these investments implies relatively close stops and profit-taking targets. In these circumstances, leverage is often used to increase trading potential.
Due to the many trades, trading costs are significant. This is why day traders prefer highly liquid currency pairs. For these strategies, the relevant “low-cost” brokers are chosen.
Many day traders seek the momentum effect of a risk-on (high-risk assets demand) or risk-off (low-risk assets demand) market sentiment. The trader tries to “carve out” a share of the predominant sentiment.
Trading around key events (economic news) is also standard practice. When the market is volatile and movements in a particular direction are fast and sharp, day traders discover favorable opportunities.
Technical analysts often develop intraday strategies. Most often, positions are opened in the direction of the main trend (identified on a higher time frame chart, such as daily, weekly, or monthly). Traders analyze shorter time frames (minutes and hours) for familiar continuation patterns (e.g., flags and pennants). Familiar configurations allow the systematic application of money management rules. Usually, the reward/risk ratio is 2:1 or more. Less frequently, day trading strategies are countertrend or range.
Some traders open several trades simultaneously. In these situations, the relationship between these positions should be assessed. If the correlation between pairs is high, the danger of all positions profiting or losing at the same time is highly probable. Different limits can control individual position losses and portfolio risk.
Intraday strategies are frequently automated, removing the emotional aspect of trading.
Swing Trading
This trading style involves maintaining an open position for more than a day but no longer than a few weeks.
Swing trading can follow purely technical rules or be combined with fundamental analysis. Swing trading is often used for stock trading, where the market consumes certain information (such as corporate reports) within several trading sessions.
Most traders prefer to trade with the underlying trend. Some range and reversal strategies are also popular among swing traders.
Technical analysts typically determine the primary trend using daily and 4-hour price charts and then define entry points, price targets, and stop limits based on shorter time intervals.
Good planning of trading costs is necessary. Transaction costs are lower than those of more aggressive strategies, such as day trading, but rollover costs may increase.
Range Trading
Markets move in a trend about 20% of the time, and the other 80% have no clear direction. Range trading is primarily a technical style aiming to profit when prices consolidate. Price consolidations occur during periods of equilibrium between buyers and sellers.
Reaching support levels is an opportunity to buy (and close short positions) while approaching resistance levels is an opportunity to sell (and take profits on long positions). A range will be exploited until a breakout disrupts the pattern.
Like any strategy, this one has its imperfections. Forming a clear range takes time. Most traders want to see at least two bottoms and two tops forming the lower and upper boundaries of the movement. By this point, much of the consolidation may have already taken place. Additionally, the presence of tops and bottoms does not ensure they won’t be breached by a few pips (a so-called false breakout), which could expand the range.
However, hitting stops could be expected. Range trading allows a high reward/risk ratio. Stop-loss orders are usually placed close to the order price (below-range support on buys and above-range resistance on sells), and the price target is situated far away at the other end of the consolidation.
Different oscillators, like the RSI or the Stochastic Oscillator, are used to filter opening and closing trades better. A long position set-up might be identified if the oscillator signals “oversold” values near the support zone. If the oscillator signals an “overbought” situation around resistance, it is probably time to consider shorting.
Long-term Positioning
This trading style involves long-term position management, sometimes exceeding a year. The investor (the word trader seems inappropriate for such a time horizon) thoroughly analyzes the economies representing the two currencies. Monetary policies and macroeconomic forecasts are usually on focus.
Long-term positioning suggests a higher tolerance for adverse price movements in individual currency pairs. However, this doesn’t necessarily mean the overall portfolio risk is increased.
The concept of long-term positioning is based on traditional portfolio management, where the “buy and hold” strategy is particularly popular.
Equity assets appreciate over time. Currency trading is different in its genesis from the stock market. Since each pair reflects the performance of two economies, prices cannot move in one direction indefinitely. FX market behavior is generally mean-reverting, with pairs tending to revert to their median values.
However, a currency pair can move in a trend for months or years. Long-term traders seek to capture these movements. Typically, they combine several FX pairs in a portfolio to achieve a specific risk profile. By diversifying, they reduce risk while maintaining similar return expectations.
Under this strategy, investment decisions are most often made through fundamental analysis. Technical levels may be used for stop-loss and take-profit management.
This strategy is often applied to pairs with a positive rollover rate, adding income to the expected price change gain.
In theory, passive investing minimizes trading costs (spreads and commissions) and should achieve higher returns than active trading. It is suitable for people looking for a long-term analytical approach to investing.
Carry Trading
The broker automatically charges a positive or negative rollover rate when a position remains open overnight. This rate reflects the difference in the countries’ interest rates. If the annual interest rates in Australia and Japan are 5% and 0%, respectively, a long AUD/JPY position (buying the Australian dollar and selling the yen) should yield an annual income of 5%. A short position in the same pair (selling the Australian dollar and buying the yen) will cost 5% annually.
Traders borrow in a low-yielding currency (funding currency) and invest in a high-yielding currency (target currency). If, in a year, the pair’s price is the same, the income will equal the interest rate differential. This effect can be magnified using leverage. Of course, losses can also increase.
Carry trade strategy implies open positions for months or years. It usually works well in periods of sustainable global growth.
Traders need to choose well the currency pairs in which to invest. They strive not only for interest income but also to achieve a positive result from a change in the exchange rate.
Given the nature of this trading style, monetary policy is the focus of analysis. The prospect of further interest rate increases is of great importance. The expectation that an Australian interest rate will rise from 5% to 6% could increase demand for AUD.
However, when times get more turbulent, and the market goes into a more defensive (risk-off) mode, unfavorable price changes can be sharp and lead to rapid losses. For example, low-interest currencies such as the yen are considered safe-haven. If global risks increase, a large capital volume will seek security in Japan.
Conclusion
Defining an investment style and strategy establishes the framework for investment decisions. While most traders adhere to a specific approach, many also construct a portfolio of various trading strategies (usually trading algorithms) to achieve greater diversification.
