Types of Single-Asset Strategy
Welcome
Hello and welcome to our seventh article. This issue discusses the main types of strategy when trading a single asset. All articles are saved at our Medium page and on the IQT website, which has a clickable version of the map of all articles: https://theiqt.com/blog.
These articles are based on my experience from consulting and product development at The IQT. Do let us know if there are topics you would like us to cover, questions you would like to resolve, or if there are insights you would like to share from your own experience.
Last Time
In Article 6 — “An Example — The Moving Average Crossover Strategy (Part 2 of 2)”, we discussed methods of trade management, i.e. trailing stops, partial closes and scalping.
Overview
When trading a single asset, there are 3 main types of strategy:
1. Momentum / Trend-Following / Continuation: Trading in the current direction of price movement, assuming the price trend will continue
2. Contrarian / Mean-Reversion / Reversal: Trading against the current direction of price movement, assuming the price trend will reverse
3. Channel / Volatility: Trading assuming that price will maintain a certain level of volatility
2 further types of strategy are arguably derivatives of momentum strategies.
4. Breakout: Trading after price reaches a certain threshold, assuming momentum will follow
5. Event: Expecting a price movement after an event e.g. a news announcement. This can also be seen as a special case of the breakout strategy.
Main Points
At any point in time, the price of an asset can move in 3 main ways — up, down or stay the same. Below is a diagram of a price movement which seems to indicate an upward trend overall. We can discuss the type of strategy with reference to what we expect to happen in the future, i.e. to the right of the vertical dotted line.
1. Momentum (upward green arrow)
If we expect price to continue upwards, we can follow a momentum strategy such as the Moving Average Crossover strategy. See the previous 2 articles for more details: part 1, part 2.
2. Mean-Reversion (downward red arrow)
If we expect the trend to reverse and for price to move downwards, we can follow a reversion strategy such as the Bollinger Band strategy. For more details, see the entry at babypips.
3. Channel (sideways blue arrow)
The final scenario is that we expect price to move much. Standard trading using simple buy and sell orders cannot profit from this situation if the channel is narrow. Instead we can make use of options to structure an appropriate instrument e.g. a straddle. For more details on this, see Investopedia.
Further strategies
We might distinguish 2 further types of strategy;
4. Breakout
We can identify thresholds beyond which we expect sudden price movement, such as support and resistance. E.g. if we believe that price has closed above resistance in the final candle in the diagram from before, we might expect price to continue upwards. This continuation is the reason why breakout strategies can be seen as a special case of momentum strategies.
We have also come across “fake outs” which are less common and can be seen as a special case of reversion strategies; in this case price closing above resistance would lead us to believe that price will reverse downwards instead of continuing upwards.
5. Event
Soon after events relevant to the market e.g. news announcements, we might expect sudden price movements. Event-based strategies are sometimes seen as a special case of breakout strategies in the sense that there are sudden price movements after the announcement. However, they are not continuations of existing price movements and can be independent of the previous price action, so in that sense they are a separate type of strategy.
Further Reading
We will discuss “The Fundamental Equation of Trading” in the next article.
Thanks and happy trading!
