Three types of trading principles that you should know

There are many different trading systems that are available these days. Some seem to be profitable, while others are not. Traders often make the mistake of jumping from one trading system to another. This is because they hope that they will find the trading system that can make them money. This is also known as searching for the Holy grail among technical trading systems.

But if you cut off the noise, you might notice something familiar. No matter what trading system you use, they tend to fall into one of the three main types of trading principles. The sooner you understand this, the better your chances of understanding how a trading strategy might work.

Trend following trading

The trend following type of trading is the most common one. You will see that a majority of trading systems follow this principle. The basic concept behind trend following is that you simply trade in the direction of the trend.

Trends are formed when majority of buyers or sellers overwhelm the market. This pushes price into a certain direction for a certain amount of time. Trend following is considered to be the most easiest way to trade. You can’t go wrong with it.

But the trick is that with trends, you do not know if a trend is formed, until it is formed. There are no technical indicators that can forecast how a trend will turn out to be. Therefore, the best way to deal with such trend following trading systems is to wait for the trend to establish.

After this, you can then trade in the direction of the trend and scalp away a few profits. Some examples of the commonly used trading systems based on trend following is the Ichimoku trading system. You also have the MACD and the moving average indicators which follow the trend following concept.

Counter trend following

Counter trend following method is exactly as it sounds. Taking a contrarian view of the markets. This means that you will have to trade in the opposite direction of the trend. This can happen because trends do not follow a single straight line. Rather, you will see that within trends, there are pullback which can cause counter trend movements.

Counter trend trading can be quite profitable, only if you are brave enough. This is because, the prevailing trend is so strong, these counter trend moves tend to snap back and pushes prices back into the trend. This can lead to big losses if you do not follow proper risk management rules.

But having said that, counter trend following can be a great way to make quick profits. Counter trend movements are often rapid and happen quickly. Thus, if you are positioned correctly in the market, you can stand to benefit from such counter trend movements.

Some of the examples of counter trend movement based trading systems are the oscillator divergences that you can see. These typically capture price movements near the top end of a bullish trend or the bottom end of a bearish trend.

Breakout trading

Breakout trading the last of the three. Contrary to trends and counter trends, breakout trading is a completely different beast. In this approach, you simple wait for prices to consolidate. When prices consolidate, they often tend to result in a strong breakout.

Many day traders love breakout trading because it is very dynamic and if you trade correctly, you can make some very good profits. But the risks of breakout trading are also quite high. This is because price becomes so erratic that it can move back in the opposite direction before reversing direction.

This can lead to a good position in the market being hit for a loss before prices move back in the original direction. Breakout trading still has its own cult following and for a reason. Imagine the ability to make consistent profits using this method.

Sometimes, the breakout can be so strong that you can expect bigger profits. But the fact that there is always a risk of getting stopped out prematurely tends to put off some traders.

An example of a breakout trading based system or indicator is the Bollinger band. When the Bollinger band contracts, it tells you that the market is consolidating. As a result, it will show you that a breakout is approaching.

To conclude, the above are the three main types of trading principles. No matter how fancy a trading system might look like, it tends to follow one of these principles. Therefore, the sooner you understand which of these three types of trading principles is suited for you, the earlier you are able to find a trading system that works for you.

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