All over social media there are numerous quizzes and surveys that ask you to go through it to find out what your spirit animal is, what your ideal man/woman is, what your favorite pet is, what superhero you are…
But here’s one that’s much more interesting and useful!
When it comes to trading, determining what type of trader you are will help dictate what type of trading strategy you use and how often you use it.
The good news is, it’s pretty easy to figure out what kind of trader you are. In fact, it’s almost as easy as taking a quiz on social media… except it can be a lot more lucrative too.
Today, I’m going to tell you how to determine what kind of trader you are, and why it’s absolutely crucial to your success in the markets…
Start With Three Simple Questions
If you are a beginner, you may think you don’t know enough about trading to determine what type of trader you are. But not to worry – there are people who have been trading for years who, if you held their feet to the fire, would be hard-pressed to give a definitive answer.
Of course, your type may very well evolve over time as you trade and discover new strategies, and you may find yourself morphing in and out of trader types until you figure out which type suits you best.
So how do you know what kind of trader you are? All you have to do is answer three simple questions.
1. Are you a Discretionary Trader or a Rules-Based Trader?
- Rules-Based Traders adhere to a set of rules about how they will conduct each trade. How and when to enter, when to take profits, and how and when to exit are all predetermined by their rules-based approach. Now, these systems do not account for ever-changing market conditions, but they do allow traders to remove themselves – and their emotions – from the decision-making process. If the criteria of the rules-based approach are met, a trade is executed no matter what.
- Discretionary Traders do not throw rules out the window entirely – in fact, many of them they have predetermined entry and exit strategies, but those strategies may be contingent upon subjective criteria. Discretionary traders may be using decades-old chart patterns to enter and exit their trades, but how they interpret those stock charts is completely subjective. Discretionary traders allow themselves a certain amount of discretion – hence the term – when making trades, rather than leaving every decision up to a rules-based approach.
That will help you determine what strategy or strategies you will focus on, what amount of time you will need to spend on finding and managing these trades and you will know ahead of time how long you expect these trades to take.
2. Are you a Directional or Non-Directional Trader?
If you’re interested in trading securities that move up or down, you’re a Directional Trader.
- Directional Traders assess the direction of the broader markets or individual securities, and then trade accordingly, taking long positions on securities they believe will go up in price and short positions on securities they believe will go down in price. Directional Traders can make great use of options, as they don’t need to wait for a stock to move in order to capture big profits.
If you don’t need the stock to move, but rather just stay at or near a specific price, then you’re a Non-Directional Trader.
- Non-directional trading strategies are good for when the broader markets or specific securities aren’t moving dramatically one way or the other. Non-Directional Traders don’t need to know or be able to predict whether a security will go up or down in price, and can trade to take advantage of moves in either direction. Options are a fantastic way to trade non-directionally, with strategies like straddles and strangles.
3. Are you a Short-Term Trader or a Long-Term Trader?
Short-Term Traders focus on trades that last anywhere from a few minutes to a month.
- A Day Trader attempts to profit by making dozens of trades during the trading day, exiting all trades before the market closes. Day traders are looking to make a little bit off each trade, capitalizing in small intraday fluctuations in securities prices.
- A Scalper also holds numerous trades for a very short amount of time intraday. But instead of profiting off small movements in price, the Scalper looks to profits off the bid-ask spread.
- A Swing Trader uses technical analysis to determine short-term price movements. The Swing Trader usually targets trades that will take no longer than four days.
If you prefer to stay in your trades longer than a month, that means you’re a Long-Term Trader.
A quick note about measuring success:
Winning percentage isn’t necessarily the best barometer of determining success. Traders can win better than 50% of the time, but the ratio of the amount of the win vs. loss is terrible (example, their wins only gain 10% and their losses suffer 30-40% declines; assuming the risk is the same across all trades) and they end up losing money.
Is it possible that you can win less than 50% of the time and still show a profit in your account? If you are winning more on your winning trades than your losing trades, there is a very good chance that is possible if you assume that the risk is the same across all trades.
- Buy and Hold Traders do just that – buy stocks and hold them over a number of years while they – presumably – rise in value. Buy and Hold Traders don’t worry about short-term price fluctuations or even broader market conditions. They simply wait for the value of their investments to increase.
- Income Traders buy stocks specifically to collect regular dividend payments. Typically, Income Traders are also Buy and Hold Traders and stay in trades a number of years.
- Value Traders select stocks they believe are trading for less than their intrinsic value, usually by comparing a stock’s long-term fundamentals with its current price.
Once you’ve answered these three questions, you can begin to explore different trading strategies that work for you.
Be Open to Change
The quest to determine what type of trader you are may take you experiencing and paper trading different strategies before you find one that you’re comfortable with.
Here’s your trading lesson summary:
Determining what kind of trader you are can go a long way to ensuring your success in the markets. Answer these three questions and you’ll be well on your way:
- Are you a discretionary trader or a rules-based trader?
- Are you a directional or non-directional trader?
- Are you a long-term trader or a short-term trader?
What I have given you is a framework to go start with. The more you trade, the better you’ll understand what you want out of trading, how much time you want to spend managing your trades, and how much risk you want to take on. And you’ll have a better understanding of what kind of trader you are – you’ll know what strategies you’re comfortable with.
Also, the more you trade the more comfortable you may become with more complex trading strategies, faster trades, and higher risk. Or you may not. Just be open to the possibility that you may change your trading style as you gain more experience and try new ways of playing the markets.
Be back with you soon.