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What is a Trading Strategy?

Article Details
  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 21 June 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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Trading strategies are predetermined sets of regulations that are used by investors and investment firms to manage investing activities. The rules help to create a set of standards that are utilized to determine the viability of any given trading option, as well as evaluate the degree of risk associated with a purchase or sale of various investments. The trading strategy of one firm may be somewhat different from the strategy employed by another firm. However, all investment firms operate in accordance with regulations set by the country of origin regarding securities transactions.

There are several elements that go into the development of a solid trading strategy. Of key importance is the establishment of a mechanism that measures the degree of risk versus the potential of return on a given investment. Investors and brokers often take steps to establish what is considered an acceptable degree of risk for the exchange of the chance of earning an equitable amount of return. When an investment opportunity does not appear to demonstrate the potential to earn a client an appreciable return for the amount of risk taken, the broker is likely to recommend that the client not invest in the option and seek opportunities with other securities.

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Volatility is another common element in the development of an effective trading strategy. Understanding how stable an option currently is, and how long the option can reasonably be expected to remain within a stable range of movement, can also help investors and brokers to qualify the acceptability of the option. High volatility will generally prompt many brokers to steer conservative investors away from an investment opportunity, and point them toward options that are more predictable.

One element that is usually not present with a trading strategy is the use of intuition or emotion as part of the evaluation process. While many investors like to play hunches, or buy stocks based on sentimental attachment to a company, a trading strategy tends to focus on other means of evaluating the viability of an investment. The ability to research the past performance of a security, coupled with understanding current performance, help to make it possible to project future returns. By removing emotion and sentiment from the equation, a trading strategy focuses on dealing with established facts in order to identify probable future performance.

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