Friday, March 12, 2010

Grand Strategies, Strategies, and Tactics in Trading

The recent post distinguished among Grand Strategies (basic ways that traders see markets and capture positive expectancies in their ideas), Strategies (how traders are approaching markets during their typical time frames), and Tactics (how traders are implementing their Strategies). Once we are clear about these, we can gain a better understanding of our trading strengths and weaknesses.

To use myself as an example, my Grand Strategy is to identify market structure on the day time frame as early as possible and exploit situations in which intraday sentiment is leaning the wrong way. My Strategy yesterday was to trade a range market in the morning, selling the market above the volume-weighted average price and buying the market below. During the day, my Strategy evolved to look for and exploit an upside breakout. My Tactics included selling the market in the morning when I saw buyers lifting offers and unable to push price to new highs and later buying the market when sellers could not push us below VWAP. Tactics also included taking profits at the first profit targets, given the market's low volatility and volume.

The important point is not that traders share my Grand Strategy, Strategies, or Tactics. Rather, traders need to know their own and refine these over time.

One of the most common problems among traders who are early in their development is that they have not crystallized a Grand Strategy. They can't really articulate their edge in the marketplace. They trade an Elliott Wave pattern one day, a short-term chart formation another day, etc. There is no overarching framework for making sense of market movement and formulating day to day Strategies.

I'm not sure it's important whether your Grand Strategy is technical or fundamental; quantitative or discretionary. I am sure that it's important to have a Grand Strategy. If you don't know your edge and cannot formulate it succinctly, you won't have the inner confidence to weather trading setbacks. Your Grand Strategy speaks to who you are, how you perceive markets, and--in an important sense--how your mind works. Companies and traders are similar: they fail when they don't clearly formulate Grand Strategies or when they stray from these.

Other times traders have clear Grand Strategies but struggle to translate these into concrete Strategies on their time frame. Very often, this is the result of a lack of preparation. I need at least an hour before the market opens to observe how we've traded overseas, how related asset classes are trading, which economic reports are due out, which news items have hit the tape, and how various indicators have been behaving. All of this information helps me arrive at a hypothesis regarding evolving day structure, which will then help me formulate a trade idea. If I don't prepare in this way, I'm likely to forget day structure and market trend status altogether and simply trade Tactically. I'll buy into strength simply because it looks like we'll break out, or I'll fade a move because volume seems weak. Those impulsive, reactive trades are often overwhelmed once the market follows its auction-based pattern on the longer time frame.

Tactics implement Strategies; they do not substitute for them.

Tactics that apply across a variety of market conditions become Trading Rules. These High Level Tactics include rules regarding position sizing, execution of trades, defining market targets and stops, etc. Even sound Strategies can be undone by poor use of Tactics. This typically leads to situations in which frustrated traders see that their ideas were correct, but that they didn't make enough money from them. Sound Tactics enable traders to take minimal losses when their Strategies are incorrect.

The distinctions among Grand Strategies, Strategies, and Tactics are useful in guiding coaching and self-coaching. They are also useful in framing your entries in trading journals. The better you understand your trading business, the more able you'll be to look at it critically and build its strengths and correct its shortcomings.