Tuesday, March 09, 2010

Strategy and Tactics in Trading

Many trading problems--and misunderstandings--result from a confusion between trading strategy and trading tactics.

First let's talk about Grand Strategy. Grand Strategy frames our most important values; it expresses our broadest aims and thus guides the specific strategies that we follow.

For instance, the Grand Strategy for a business might be to become the highest quality producer of green automobiles in the world. "Quality" and "green" represent key values for the company; "automobiles" represents an area of expertise. The company will find its success by sticking to its Grand Strategy; not by shifting its focus to the production of household goods or by trying to produce low quality SUVs at low prices.

To realize its Grand Strategy, the business must engage in a variety of smaller Strategies: product development strategies, marketing strategies, sales strategies, etc. For example, the automobile company may focus its marketing and sales strategies on the Asian markets, perceiving unusual opportunity there for high quality, green vehicles. Strategies can change--Asia may become less of a focus if a trade war ensues--but usually not on a dime. Strategies guide concrete, day-to-day, week-to-week activities in the service of those Grand Strategies.

The way the business implements its Strategies is through Tactics. Tactics might include a rebate policy to enhance sales or an advertising campaign designed specifically for Asian markets. Tactics are designed to achieve specific objectives toward a successful Strategy. When tactics don't work, they are quickly modified and even replaced. The successful company remains true to its Grand Strategies, but flexible in its Strategies and especially in its Tactics. If we think of the conduct of war or the game planning of a championship football team, we'll see the same dynamics of Grand Strategies, Strategies, and Tactics.

The Grand Strategy of a trader represents his or her fundamental way of viewing markets and edge in the marketplace. Trend following is a Grand Strategy, as is mechanical systems trading, Elliott Wave trading, order flow trading, or trading day structures from auction theory. A trader's Grand Strategy captures how he or she views markets and defines opportunity.

The trader's Strategies will define how he or she finds opportunity in the present set of market conditions. For example, my Strategies as a portfolio manager might be to buy dips in the stock and commodities markets because I view this as a cyclical bull market fueled by low interest rates and growth among emerging economies. On a day-to-day basis, I remain true to my Strategies, but over the course of the year, I'm likely to modify or even abandon them.

When it comes to Tactics, I as a trader will be even more flexible. My Tactics may lead me to take profits in stocks right here, even though I think we'll be headed for new price highs in the weeks ahead. My Tactics may also lead me to hedge my gains with some options at these levels, given risks perceived in the days ahead. Alternatively, my Tactics could lead me to add to positions on a pullback in the stock and commodities markets.

Clearly, Strategy will differ for a portfolio manager and a trader; for a day trader and for an investor. My reading of day structure may guide my Strategy as a day trader. It may guide my Tactics if I'm a longer-term position trader. Usually, Strategy is the idea or theme that you're trading; Tactics is how you execute and express that idea or theme.

Many traders fail because they jump from Tactic to Tactic, without a clearly formed Strategy and without an overarching, guiding Grand Strategy. They are focused on setups, not ideas. More on this in my next post in the series.