There are different strategies available to traders, but not all would be suitable for everyone and every market. While some may prefer trend-following strategies, others may prefer mean-reversion strategies. But what are the best trading strategies?
There is no one best trading strategy out there. Experienced traders know that there is no Holy Grail strategy in financial trading, so they make use of different strategies. The best strategies are those that complement each other during different market conditions. For example, trend-following and mean-reversion strategies complement each other very well — trend-following strategies when the market is trending and mean-reversion strategies when the market is range-bound.
In this post, we take a look at the best trading strategies, and at the end of the article, we provide you with a few backtested trading strategies.
What are the best trading strategies?
Financial trading is a probability game. What matters is the odds of any trading strategy performing well in diverse market conditions and across different markets. Generally, the market can move sideways or be in a trend. A good strategy manages to remain profitable in different market conditions or at least make more in favorable conditions than it’s losing in poor conditions.
There is no one best trading strategy out there, as there is no Holy Grail indicator or price action setup that works all the time.
Experienced traders know this, which is why they make use of different strategies. The best strategies are those that complement each other during different market conditions. For example, trend-following and mean-reversion strategies complement each other very well — trend-following strategies work best when the market is trending, and mean-reversion strategies work best when the market is range-bound.
- Does your trading strategy complement your portfolio of strategies?
- Trend Following Trading Strategies and Systems Explained
- Do Trend Following Trading Strategies Work? Why Does Trend Following Work?
- Mean Reversion Trading Strategies and Backtest
It is typical for an experienced trader to use different complementary strategies to diversify so that when market conditions change, they would still remain profitable, as the strategies that are performing well during that condition would offset the losses from the strategies that are not performing so well. Being able to select complementary strategies and the best timeframes becomes a skill. But things are a lot easier if the strategies are automated so that backtesting and optimization would be faster.
- Mechanical Trading Strategies – Advantages with Mechanical Rules and Edges
- Mechanical Trading Strategies Vs. Discretionary Trading Strategies
So, the first step to identifying the best strategies for your trading style is converting your strategies to trading algos. After that, you backtest and optimize them. Then you analyze the results, studying the performance per market conditions.
Generally, mean-reversion strategies don’t tend to perform so well when the trend is very strong, but they can be amazing during ranging conditions. The opposite is true for trend-following and momentum strategies, which tend to do poorly in range-bound markets and perform well when the trend is strong.
Types of trading strategies
There are different types of trading strategies, but the most common ones are mean reversion and trend following — two opposing but complementary strategies. Other strategies are momentum, breakouts, and reversal. Let’s take a look at them.
Trend following is a strategy that aims to capture the extended moves in a trending market. The aim is to capture most of such moves, not all, but the majority of them. Trend followers are not trying to predict tops and bottoms. They simply want to identify a trending market and milk the profits for as long as it lasts. Examples of trend-following strategies include:
- Bollinger Channel Breakout strategy: In this strategy, a band of 2.5 standard deviations is added to the 350-day moving average. If the price closes above the top of the channel, a long position is entered, and if the price closes below the bottom band, a short position is entered.
- Dual Moving Average strategy: This strategy uses two moving averages: a 100-day moving average and a 350-day moving average. A buy signal occurs when the shorter moving average is above the long moving average, while a sell signal is generated when the shorter moving average is below the longer one.
- Triple Moving Average strategy: This strategy uses three moving averages: 150, 250, and 350-day moving averages. Buy occurs when the 150-day moving average breaks above the others, while a sell signal is generated when it is the others. The 350-day average is used as a trend filter: the 150 and 250 moving averages must be above it for a long signal to be valid, while they must be below it to have a valid sell signal.
We have backtested many trend-following strategies in our article about Turtle Trading Strategies.
Mean reversion is a trading strategy that is based on the central tendency of time series. In statistics, most time series have a central tendency which is the natural inclination of the variables to cluster at the center — the mean. In the case of price, the price is likely to return to its mean (moving average) whenever it moves significantly away from it.
Hence, when the price is significantly below its mean, it could be a time to buy, and whenever it is significantly above its mean, it could be a time to sell. There are different strategies traders use to exploit this tendency. Here are some of them:
- The Bollinger Bands strategy: In this strategy, traders use the Bollinger Band indicator to know the price mean and when it is significantly above or below the price. The middle line of the indicator is a 20-period average, while the outer bands are 2 standard deviations away. A rise above the upper band could be a signal to sell while a fall below the lower band could be a signal to buy.
- The momentum oscillators: Momentum oscillators, such as the RSI and stochastic, which show overbought and oversold market levels are good for mean reversion strategies.
- The price action strategy: Here, the trader uses the price action structure and moving average to formulate a trading strategy. A good example is the 5-day low strategy in the S&P 500.
The stock market is very prone to mean reversion. Please have a look at our backtested results to what happens under such conditions (and what we mean by oversold and overbought):
Breakout trading is the strategy of entering a new trend early, from when the price breaks out of its range. This strategy is commonly used by day traders and swing traders, as it takes advantage of short to medium-term market movements.
Traders who use this strategy often look for local support/resistance levels or chart patterns (like a symmetrical triangle strategy and wedge trading strategies) and wait for the price to break out of the key level. Breakouts are usually accompanied by periods of high momentum, which the trader aims to ride.
It is common to use a stop order beyond the support or resistance level so that any breakout executes a trade automatically, but that is frequently accompanied by fake-outs — where the price spikes through the level to trigger orders without eventually breaking out.
A true breakout happens only when the price has closed beyond the price level in question, and that must be accompanied by a larger volume than usual. Some volume indicators for trading breakouts include the money flow index (MFI), on-balance volume, and the volume-weighted moving average.
Momentum trading strategies are similar to breakouts in that they aim to trade in the direction of the trend.
However, while breakouts focus on an emerging trend from breakout, momentum strategies try to capture the impulse swings in the direction of the trend. Traders who use this strategy wait for a pullback to be over and for the price to show that it is about to continue in the trend direction. Momentum oscillators are good for trading this strategy, as they can be used to target oversold situations in an uptrend and overbought situations in a downtrend.
The reversal trading strategy is based on identifying when a current trend is going to change direction. A ‘bullish reversal’ indicates that a downtrend may be about to turn into an uptrend, while a ‘bearish reversal’ indicates that an uptrend will likely turn into a downtrend.
Reversals often use chart patterns, such as the head and shoulders pattern, Quasimodo, double top pattern, double bottom pattern, and wedges (a rising wedge in an uptrend and a falling wedge in a downtrend).
Best free trading strategies
It is not always easy to free quantified trading strategies. Most of the strategies you would find online are discretionary. But at Quantified Strategies, we offer hundreds of profitable and free trading strategies, most of which are backtested. They need some tweaking to suit your broker, the markets you intend to trade, and your risk parameters.
The strategies on that page range from trend following to mean reversion. There are also several momentum and breakout strategies. However, they are grouped according to the assets they have been tested on and their characteristics. So, you will find categories like:
- S&P 500 strategies
- Nasdaq trading strategies
- Russell 2000 strategies
- Treasury bond strategies
- Day trading strategies
- Overnight strategies for stocks
Go to the page to find strategies that suit your trading style and test them out. You may need to tweak and backtest them to see if they suit your game.
Best trading strategies examples
As a trader, you must have multiple uncorrelated strategies to diversify your game. The best strategies should be ones that complement each other. It is not good enough to have only trend-following strategies or only mean-reversion strategies.
In fact, trend following and breakouts or momentum strategies are not good enough since they base on the same market conditions — the ability of the market to surge in one direction — with the only difference being in the entry and timing.
The best strategies to deploy are combinations of trend-following and mean-reversion strategies since they are usually uncorrelated. Here are some free mean-reversion and trend-following strategies you can deploy:
This strategy is for the ETF that tracks the consumer staple sector. The ETF has the ticker code XLP. The rules of this mean-reversion strategy are as follows:
- Calculate an average of the H-L over the last 25 days.
- Calculate the (C-L)/(H-L) ratio every day (IBS).
- Calculate a band 2.25 times lower than the high over the last 25 days by using the average from point number 1.
- If XLP closes under the band in number 3, and point 2 (IBS) has a lower value than 0.6, then go long at the close.
- Exit when the close is higher than yesterday’s high.
An IBS short strategy in FXI
FXI is the ticker code for the Chinese ETF. It has shown strong mean reversion tendencies over the last decade. The good thing about the strategy is that it allows you to diversify into the Chinese market. The strategy has worked pretty well over the last few years. Here are the rules:
- If today’s IBS (C-L)/(H-L) is higher than 0.9 then short at the close.
- Exit at the close when the IBS is 0.25 or lower.
This is a very simple mean-reversion strategy that is made for the S&P 500.It is easy to code. Here are the rules:
- If today’s close is below yesterday’s five-day low, go long at the close.
- Sell at the close when the two-day RSI closes above 50.
- We have a time stop of five days if the sell criterium is not triggered.
Trend-following strategies you can combine with the mean-reversion strategies above include these:
This is a volatility-based trend strategy. A 7-period ATR is added to the 350-day moving average of the closing prices, and 3-period ATRs are subtracted from the 350-day moving average. The rules are as follows:
- If the price closes above the channel, go long on the open of the next day; exit when the price falls below the 350-day moving average.
- Go short if the close is below the channel; exit when the price rises above the 350-day moving average.
This Donchian trend system has two components: the trend filter requires the 25-day exponential moving average to be above the 350-day moving average. This system uses a 2 ATR stop loss or exit after 80 days without using any stops whatsoever. Here are the rules:
- If the trend is up and the close sets a new 20-day high, a long position is initiated on the open the next day
- If the trend is down and the close sets a new 20-day low, a short position is initiated on the open the next day
Best trading strategies – conclusion
To sum up, the most crucial thing in trading is to have strategies that complement each other. One strategy doesn’t need to be super good on its own, but it might add much value to your portfolio of strategies. Thus, please don’t throw away strategies unless you have measured them on your overall portfolio.
The best trading strategies usually do not have the best average gains or equity curve!