The Different Types of Trading Strategies

Barrel shooting and trading strategies are the two basic ways of stock market trading. Stock trading strategies are used by investors to determine the stocks to buy and the time to sell. It also helps them protect their investments. Trading strategies outperform barrel shooting by a large margin. The different types of trading strategies, which count to over a hundred, are tried and trued methods that have worked well over many years. Before exploring new strategies, beginners in the world of investments are advised to investigate some of the basic trading strategies first.

Hedging

The way of protecting an investment through the reduction of the risks that are involved in holding a particular stock is called hedging. Buying a put option that allows the selling of the stock at a particular price within a certain period of time can offset the risk of a decrease in the stock prices. There will be an increase in the value of the put option once the price of the stock falls. The most expensive hedging strategy is to buy put options against individual stocks. People with broad portfolios will do better if they buy a put option on the stock market itself because it will protect them against general market declines. Selling financial futures such as the S&P 500 futures is another way of hedging against market declines.

Dogs of the Dow

Dogs of the Dow, which gained popularity during the 90s, is a strategy that involves buying of best-value stocks in the Dow Industrial Average. These are ten stocks with the lowest P/E ratios and the highest dividend yields. This strategy presents the idea that the ten lowest companies on the Dow have the most potential for growth over the coming year. The companies listed on the Dow Index are those which offer a reliable investment performance. Pigs of the Dow is a new twist on the Dogs of the Dow. In this strategy, five of the worst stocks on the Dow are selected by looking at the price decline percentage from the previous year. Like in the Dogs of the Dow, the idea in Pigs of the Dow is that the worst five stocks are going to rebound more than the others.

Buying on Margin

The strategy of buying stocks using borrowed money, which is usually from the broker, is called buying on margin. Because they receive more stocks despite the low initial investment, the investors are given much more return by margin buying than by full payments. In the event that the stock loses its value, the losses in margin buying will also be correspondingly greater. In order to limit the losses in case of market reversal, investors should have stop-loss orders when they buy on margin. The margin amount has to be limited to about 10% of the total account value.

Dollar Cost and Value Averaging

The strategy that involves the investment of fixed dollar amounts on a regular basis is called dollar cost averaging. One example of this is the monthly buying of shares from a mutual fund. A drop in the price of the fund will cause the investors to receive more shares for their money but a raise in the price will cause the fixed amount to buy fewer shares. Value averaging, which is an alternative to dollar cost averaging, involves the decision of the investors to set a regular value that they wish to invest on. For example, the investors decide to invest $100 per month in a particular mutual fund. If the price of the fund increases, the investors also put in a higher dollar amount in that fund but if the price of the fund decreases, they spend less money. This will average out their investments to the original $100 per month. Value averaging, as a percentage return on the money invested, outperforms dollar cost averaging most of the time. When used as a part of broader trading strategies, value averaging can actually help in securing the growth of investment funds.