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Types of Equity Trading

Types of Equity Trading

Equity trading offers options from trading in the very short term (for a few minutes) to a few days or weeks. The underlying themes in equity trading are trend and inefficiency. Trend refers to an underlying pattern that the stock follows and you take a trade based on this pattern. The key is to identify the pattern before the market enters into it. Inefficiency occurs when there is mispricing in the market. The equity trader immediately locks in a trade on the assumption that sooner rather than later the market will come back to efficiency.

Important types of equity trading

  • At the shortest end of the trading range, we have intraday trading where traders can buy or sell stocks for covering in the same day. When you place the trade, you must specify it as an intraday trade. Only then you get the benefit of lower margin requirement. Intraday trading can be either on the long side or on the short side, but have to be covered on the same day.
  • Trend trades are those that last for a few days to a few weeks. These patterns can either be news based or technical chart based. For example, when a stock forms a double bottom or breaks above a resistance then it forms a pattern that can be capitalized on. Similarly, positive news flows can also create trend for short term traders.
  • Another form of trading is called price action trading, which is purely based on news flows. Here the trader purely goes by news flows and announcements and takes positions based on how much a stock would react to the news. Larger impact stocks will see larger positions being taken. This is a slightly risky form of trading and entails a higher degree of exposure risk.
  • Then, there are scalpers and market makers who trade just when there are small mispricing opportunities. Market makers give buy and sell quotes on the same stock so that when both legs get executed they make the spread. Market makers and scalpers work on very thin spreads and operate with large volumes for profits.
  • Finally, there are arbitrageurs who focus purely on price differences. There were arbitrageurs between stocks exchanges but that does not exist any longer. Nowadays, arbitrageurs focus on the spread between stocks and futures on that stock to lock in the price difference for assured profits. This is a fairly low risk trade and almost operates like a fixed income product.

Three approaches and what works

Just as there are different types of traders, there are also different ways in which these traders approach their trading philosophy. Here are 3 popular approaches.

  • Trend followers are the most common types of traders. They typically focus on identifying the trend and then trade based on that. Such trend followers always believe that the market is the king and their job is to identify the message of the market and trade accordingly. For them the market momentum is supreme and the always prefer to trade on the same side as momentum. This largely reduces their risk.
  • Then, there are contrarian traders who try to outguess the market. Of course, contrarian traders do not do it every day but only when they find that the market is wrongly interpreting a data point they take aggressive positions against the market. This is a risky strategy but can be very profitable if you are able to get it right.
  • Finally, there are range traders who purely go by charts. The charts define the range of the stock and these traders take buy and sell positions within this range. Their focus is more on what is the risk-reward ratio at different ends of the range.
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