Trading Strategies
This note will describe the main categories of trading strategies.
There are 2 main trading strategies: Trend Following and Mean Reversion.
There are other strategies as well, but they will be elaborated on at a later stage.
Trend Following
Objective: To enter when a new trend is established, and exit when the trend is over.
Indicators:
Moving averages (most common)
Trendlines
Average Directional Index (measure trend strength)
Linear Regression (forecast, slope)
Supertrend
Challenge: Maintain small losses for losing trades.
Summary
Trend following have a few great trades with larger profits, and small losses on a larger amount of trades. Can go through periods of poor performance.
Mean Reversion
Objective: Assuming the price will revert back to a mean. Look to buy oversold, and sell overbought.
Indicators:
- Relative Strength Index
- Bollinger Bands
- Disparity Index (distance from moving average)
- Stochastic oscillator
Challenge: Mean reversion is exposed to left tail risk (huge infrequent losses). Can take a long time to recover from big losses.
Summary: Mean reversion typically have small consistent profits, and low volatility in the strategy.
Trend Following vs Mean Reversion
Comparison of key performance metrics:
| Performance Metric | Trend Following | Mean Reversion |
|---|---|---|
| Win rate | Low | High |
| Trade duration | Long | Short |
| Number of trades | Low | High |
| Profit per trade | Higher | Low |
| Volatility | High | Low |