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A Detailed Look at The Trading Process

Updated: May 9

Welcome


Hello and welcome to our fourth article. This issue explains the trading process in more detail, with respect to the various stages involved in executing a (systematic) trade. All articles are saved at our Medium page.


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These articles are based on my experience from consulting and product development at The IQT. Do let us know if there are topics you would like us to cover, questions you would like to resolve, or if there are insights you would like to share from your own experience.


Last Time


In Article 3 — “Buzzwords Demystified: Systematic vs Automated vs Algorithmic vs Quantitative vs Machine”, we discussed the many terms which largely refer to the same concept, that of non-manual trading, albeit with different nuances. While “automated” may be the most precise, we will adopt “algorithmic” as it is the most commonly used.


Overview


The trading process is Analysis → Setup → Entry → Management → Exit.


1) Analysis and Setup are the stages involved in preparing for trading


2) Entry, Management and Exit are the stages involved in executing trading


Main Points


Overall, the trading process in general looks like:


The trading process


At the simplest level, the trading process consists of 2 stages — the execution of the actual trade and (hopefully!) preparation beforehand. We will now examine the stages and their components further.


1) Preparation


Analysis of information relevant to the asset(s) to be traded should be done before placing a trade, to maximise the probability of profit. Analysis aims to identify a setup — a trigger or signal for the trade, based on which a trader decides whether or not to place the trade.

Analysis:


Analysis can draw upon many different fields. The main dichotomy is between Technical Analysis and Fundamental Analysis.


Technical Analysis is the usage of price, volume and time information on charts to identify patterns and so determine setups, trade entries and exits. It is not respected academically (although some academics like Professor Andrew Lo have started to incorporate it e.g. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=228099). Regardless, it has been shown to have short term value so is relevant to trading.


Fundamental Analysis is the usage of economic factors to determine the value of an asset and so determine the trading strategy. It is more relevant for longer timeframes but is also important around the times of news events e.g. unemployment data announcements.


We might also define more quantitative forms of analysis, though these terms are not standard.


Theoretical Analysis: Uses Mathematics, Computer Science and Economics including Market Microstructure to take advantage of the market, as in HFT.


Data-driven Analysis: Uses Data Science, AI (ML) and Econometrics / Statistics to extract patterns from data to determine the trading strategy.


Setup:


Let’s define a setup as a situation where a user may wish to enter a trade, based on their analysis (i.e. a specific trigger or signal). Then a trade is a setup which progresses to placing an order. Not every setup may progress to a trade, e.g. there may be too many trades active already, so a trader may choose to ignore new setups.


2) Execution


Trading is the process of buying and selling assets in the hope of profiting from buying low and selling high. It occurs over relatively short timeframes e.g. 1 minute upto 1 week.


· “Investing” is similar but usually implies longer timeframes e.g. 1 month to years.

Warren Buffett is an investor. George Soros is a trader.


The amount we buy or sell is often called the position. Stake is also used but usually for betting, not trading.


If we buy first and then sell later, this is referred to as a long position or sometimes even as a buy trade. What is key is that the asset is bought first.


• The trade can be thought of as a group of decisions or orders.


• The first order for a long trade is to buy. Entry order / opening order can be used to refer to any first order.


• The final order for a long trade is to sell. Exit order / closing order can be used to refer to any final order.


If we sell first and then buy later, this is referred to as a short position or sometimes even as a sell trade”.


• In this case there is a sell entry and a buy exit.


Confusingly, people sometimes refer to the individual orders as trades themselves. E.g. they say that a long position consists of an opening buy trade and a closing sell trade. You may notice a lot of conflation of terms online, and there may not be a correct or standard definition of any, but we will try to be consistent and define ours according to our viewpoint.


More sophisticated trades may have intermediate orders, i.e. they may comprise an entry order, possibly multiple intermediate orders, and finally an exit order. Trade management is commonly used to refer to the intermediate orders together with the exit order. We re-define it to mean just the intermediate orders. E.g.:


Entry: a trade may start with a buy order


Management: the position may be added to with more buy orders


Exit: the whole position accrued may be sold (the position is closed).


Further Reading


We will illustrate the trading process further in “An Example —The Moving Average Crossover Strategy (Part 1 of 2)”.


Thanks and happy trading!

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