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[S416]Short Term Trading Strategies

by Gaurav, Gau

There are primarily three types oftraders/investors in the stock market:

Investors: Those who expect minimum 30-40% appreciation and are willing to hold between two months to a few years. They enter only long positions and usually select a scrip based on fundamental analysis. Medium-long term investors can utilise technical analysis to time their entry and profit booking better.

Day traders: Day traders enter long/short trades to square up the same day. They usually base decisions on technicals, information or at times, gut feel.

Short-term traders: Short-term traders expect 5-20% returns within 2 days to 3 weeks. They enter long as well as short positions. These include:

Position trading, where one either buys a stock and holds for the required appreciation, or sells from an existing long (or borrowed) position to cover at a lower level.

Futures & options trading

The popularity of Short-termtrading, is on the rise due to the following reasons:

It provides an opportunity to make substantial profits in a short period and ensures continuous rotation of capital.

As against long-term investment, short-term trading has limited downside because of strict stoplosses.

Short-term trading has less demand on the traders time, while day trading requires full-time attention at the terminal. Hence, even those who pursue other professions can do short-term trading.

One can leverage on margin in case of short-term trading in futures.

Short-term trading in options requires smaller investment and has limited risk.

Like every discipline, short-termtrading also has its Dos and Donts. These are not well understood by all. Thisarticle outlines these rules, which would make short-term trading a relativelysafe and satisfying experience.

Basic Principles of Short-termTrading:

The first principle is to do few trades. At any point, one should not have more than 6 trades outstanding. A good number is 3-5.

Equal capital allocation: Divide your short term trading capital equally into each trade. Ideally if one has Rs 1 lac of capital, one should put around Rs 20,000 in each trade.

Clear Targets and profit booking: While entering a trade, one should be clear about the target price he expects to achieve. Once the target is reached, profits should be booked promptly. Here, some traders often fall to the greed-syndrome and hold on for more profits. This, more often than not, leads to losses in the long run.

Strict stoplosses: No strategy, however good, can ensure 100% success. A strategy that yields above 65% success rate is reasonably good.

But there is a catch here! 65%success means you achieve your targets in 2 out of every 3 trades. But how muchdo you lose in the third? This is what determines your overall profitability.

The following example illustratesthis: Suppose one invests Rs 10,000 in each of the 3 trades. The 2successful trades fetch a profit of RS 1000 (RS 500 each) at 5%. Now, if thestoploss on the third unprofitable trade were also around 5% (includingbrokerage), he would lose RS 500 on it. Thus, his net profit across the 3trades is RS 1000 RS 500 = RS 500. This is around 1.67% net return on the totalcapital of RS 30000. And considering that this is short term trading, theaverage holding period may be a fortnight. Therefore, the annualised returnwould still amount to 1.67% x 26 (26 fortnights in a year) = 43% per annum. Nota mean achievement by any standards.

But in the same example, if thetrader does not have a stoploss, he continues to hold the loss-making trade.Finally, when he realises that he is in an irretrievable situation, he squaresup the trade at say 15% loss. (In my experience, this is what happens to manytraders when market suddenly turns bearish). In this case, he makes RS 1500loss on this trade, which eats the RS 1000 profit he has made in the other two.Thus, he ends up with a net loss of RS 500 (-1.67%) on his 3 trades. At thisrate, he would wipe out his entire capital in 2.5 years.

That should forever, put to rest thedoubt whether stoplosses are needed in short-term (or for that matter in anytype of) trading! Trading is like a war, you need to lose small battles tosee another day and eventually win the war!

Dont "buy time": Often traders mix up various types of trading. For example, a trader entering a day trade carries his position overnight if the trade turns against him. Or, a short-term trader does not exit at a stoploss and converts it to a long-term investment. He hopes some day it will fetch him profit. These traders are just "buying time". Unfortunately, this works as rarely as you would find refrigerator in an igloo. Stick to your trading style and importantly; dont convert trades from one type to another.

Track your performance: A trader should monitor performance on every trade, as well as, across all trades. Remember, if trading is your business, run it like a business. Rigorously perform the forecasting, planning and monitoring that goes into it.

In a nutshell

Short-term trading has itsadvantages when compared with day-trading and long-term investment. It issuited for both full-time and part-time traders. When performed in accordancewith the basic principles, it can be an engrossing and potentially lucrativeactivity/profession.

There are numerous trading strategies that one can employ when trying to build themselves a particularly sweet portfolio. Of course, the market has changed a lot over the years and the basic idea of buy low and sell high can be interpreted to fit our current needs. Once upon a time the basic trading strategy entailed buying low and holding onto the shares for a rather lengthy amount of time. However, this strategy might not always work in todays market.

Short term trading can be very profitable. Obviously, when you are using short term trading techniques you are buying low and waiting for an increase and selling off. Some traders feel as though they would be missing a potential opportunity in this manner, like the longer they hold the more likely the profit is going to continue on a profitable track. Some traders feel that moving swiftly when profits show up is the only way to maintain a high win-loss ratio.

The greatest influential factor in producing profits is the mentality of the general population. While some aspects of the companys foundation play a role, the general population is more apt to produce fabulous results or dismal failures based on what they believe the stock is worth. Taking this bit of information into account, short term trading can actually be highly profitable.

Short term trading allows for fast action and swift decision. If you believe that the stock in question is bound to increase steadily over a period of three years, then selling off too quickly might seem like a rash decision. Since public opinion has such a strong standing on that stocks potential to produce, there is then a magic breaking point at which time the public will lose faith in the company.

Whenever a stock shows too much long term potential, the general population often decides it is about time for that stock to come plummeting down. Its almost like people are more satisfied believing that anyone who didnt jump in right away is going to miss out because it is only a matter of time before the stock starts to dwindle again. As there is some truth to this statement, it projects the probability of falling stock prices prematurely, and people begin to withdraw their funds as soon as this thought becomes relevant.

Some trader employ a totally unique strategy of pulling out and jumping back in. When a stock shows fabulous potential, they pull out and reenter with a smaller sum at a higher price, allowing for continued growth while simultaneously feeling as though they pulled out enough of their initial profit in order to stay in the game. Just like with any other trading strategy, there are flaws with this line of thought.

At the same time, since the market is nothing but flaws and theories, it can be a method of learning the process of short term trading with less risk of significant loss. Every day trader has to come to terms with the speed at which the market can change as well as the speed of which they must face uncertainty. With every new step toward high speed decision making, short term profits, and the ability to make quick and rational decisions the trader becomes that much closer to creating profits and doing so with a great deal of certainty.

Article Source : Investing and Trading

About Author

Both Gaurav & Ben Needles are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.

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