Short-Term Trading Strategy

Short-Term Trading Strategy – Rules, Performance, and Backtest Analysis

Because of its potential for quick profits, the short-term trading strategy is the most popular trading method among retail traders. Unlike traditional long-term investing methods, this strategy offers an exciting opportunity to profit from relatively minor changes in market conditions. But what exactly is the short-term trading strategy?

A short-term trading strategy is a trading strategy that aims to open and close positions in a short period, typically a few days or weeks, but it can be even shorter. Traders who make use of this strategy focus on the analysis of price movements rather than the long-term fundamentals of an asset.

In this post, we take a look at the short-term trading strategy, and at the end of the article, we make a backtest to help you get started.

What does short-term trading mean?

Short-term trading involves traders taking positions that can last from a few seconds to several days. It focuses on the short-term price movement rather than the long-term fundamentals of an asset. This trading strategy looks for periods of high market volatility, such as those surrounding important economic data releases, company earnings, and political events, to profit from the sharp fluctuations in market prices. 

Also known as active trading, this approach is not used to engage in passive investing in funds but rather it is used to speculate on financial assets of different kinds, including derivative products. In fact, most short-term traders prefer derivative instruments because they allow them to enter and exit trades without owning the underlying asset. Contracts for difference (CFDs), spread bets, futures, and options are examples of financial instruments that allow traders to profit from rising and falling market prices.

short-term-trading

Backtest or not to backtest?

Most traders use technical analysis or some other technique that is not backtested. We strongly advocate that you backtest your trading ideas. How else can you find out if you have a true edge? We have covered this in a separate article:

This website is all about trading, and we have provided hundreds of free short-term trading strategies. But we save our best strategies for our paying subscribers.

What does short-term trading strategy mean?

Short-term trading is a trading strategy that aims to open and close positions in a short period, typically a few days or weeks, but it can be even shorter. The most common users of this type of trading strategy are retail and institutional traders who hope to profit from small price movements and short-term trends. It is an alternative to the more common “buy-and-hold” strategy, in which you would hold a position for as long as you want, often several years.

Short-term vs. long-term trading

In contrast to short-term trading, which aims to make small, quick profits, long-term trading aims to make bigger profits over a longer timeframe by banking on the asset’s growth. Hence, while short-term trading focuses on the short-term price action of a financial instrument and uses technical analysis, long-term trading focuses on long-term trends and often makes use of fundamental analysis. As a result, trading over short periods is regarded as a more speculative form of investment than the traditional strategy of long-term investing or buy and hold.

Long-term trading is often done with real assets, such as equities, ETFs, and funds. Conversely, short-term trading frequently entails using derivative products such as futures, options, spread bets, and contracts for difference (CFD) but can also be done on equities with the right account size. With a CFD, you can open a buy or sell position based on whether you believe the asset’s price will rise or fall, and whether you will profit or lose depending on the market’s direction.

While both long-term and short-term trading can make use of leverage, short-term trading is more likely to involve the use of leverage because of the shorter duration and perceived reduced chance of adverse price movement.

However, leverage and margin trading carries a high level of risk, which is why long-term investors prefer to pay the full value of the position up front and take ownership of the asset. If you use leverage and you incur a loss, the amount of the loss will be calculated based on the total value of the position and subtracted from your account. This means that you could lose more than you invested unless the broker offers negative balance protection.

Before deciding whether to play the short-term game or long-term investing, you should consider your personality, the amount of money you are willing to risk, and your overall trading goals. All of these factors can potentially impact your position’s outcomes.

Short-term trading tips

Here are some tips to get you started on short-term trading:

  • Always have a trading plan: A trading plan can be considered a set of rules that govern how you should behave while trading. It is a road map you use to determine how to find and execute trades. Your trading plan should cover everything from how to find trade setups to how to manage your specific positions and how to exit. For any trader, you should have a clear strategy for how to enter a position and how to exit it.
  • Learn to control your emotions: To be successful in short-term trading, you must be able to make multiple decisions quickly while keeping a large amount of complex information in your head. The fact you’re your money and, possibly, your livelihood is at stake, creates a volatile mix of emotions. Fear of loss and greed for profits can be powerful motivators for traders. Both mental states cloud judgment, making traders more likely to make decisions that aren’t in their best interests. An easy way to reduce the effects of emotions in your trading is to automate your trading by converting your strategies into trading algorithms.
  • Practice risk management: As a short-term trader, you may choose to use stop loss to manage risks. However, you should note that while it may help to limit losses, it may not help the overall profitability of your strategy. So, consider other alternatives, such as diversification across assets and strategies.
  • Be mindful of slippage: Because of the rapidity with which short-term trades are executed, the price at which your order is executed may differ from the price at which you specified it should be executed. Limit orders may help avoid that but you may end up missing some trades.
  • Find your best time of day to trade: When the market is most liquid and when there is the most price movement can vary depending on your trading strategy. Find the best timeframe for your strategy.
  • Practice with a demo account: A demo account helps you to practice your short-term trading strategies without risking your funds. Demo accounts are often preloaded with virtual funds for practice purposes.

List of short-term trading strategies

These are some short-term trading strategies:

Scalping

Scalping is a trading strategy that focuses on extremely short timeframes. Scalpers enter and exit positions as quickly as possible (within seconds or minutes) with the aim of making little profits, and they can make hundreds of trades during a typical trading day so that their little profits can accumulate to a substantial amount. 

This group of traders doesn’t usually use fundamental analysis; instead, they focus solely on price action and technical analysis. The strategy is mostly used in forex because of the nature of price fluctuations in that market. Scalpers don’t bother about trends as their trades are closed relatively fast for any trend to develop. The risks of trading are much higher for scalpers than for other short-term traders because of the large number of trades and the resultant commission costs.

Scalping might look tempting, but the reality is that almost all scalpers lose money. Because short-term trading is mostly a zero-sum game, you can’t expect to make money at scalping.

Day trading

With this style of trading, the trader opens and closes his trade within the same trading day. This means they do not carry positions over into the next day, avoiding the fees associated with overnight positions. Day traders try to capture the price trend of the trading day and thus, focus on intraday timeframes. These traders could use hourly charts to analyze price data and identify recent emerging or declining trends to decide whether to buy or sell the asset.

Compared to scalpers, day traders have more time to evaluate their trades, reducing risk slightly. They can examine price charts to determine the highs and lows of the previous trading day, which will help them develop an efficient strategy for the current trading day. As with scalping, day trading avoids the risk of price overnight price gap, which is a risk for any position carried overnight.

We were full-time day traders for almost two decades and did pretty well. That said, most day traders fail:

Swing trading

Swing traders hold open positions for several days or weeks at a time. Swing trading is a strategy for trading in the short to medium term. Traders may examine an asset’s swing highs and swing lows to determine whether or not the asset has the potential to generate future profits, as the term “swing analysis” implies.

Most swing traders look for trading opportunities on the daily timeframe, as their game is to ride the individual price swings. They can use both fundamental and technical analysis, unlike scalpers and day traders who focus only on technical analysis and price action, but they still tend to rely more on technical analysis.

Short-term trend trading

Trading with the trend is a strategy that can be used in short-term and long-term trading strategies. In short-term trend trading, the focus is on short-term trends that appear on hourly and 4-hourly charts. The strategy assumes that the price of an asset will continue to move in the direction that it is currently headed and will not reverse direction for the duration of the position.

In general, traders will buy an asset (if it is trending upward, and they will sell the asset if it is trending downward. They use trendlines to help them identify price chart trends that are developing or shifting in direction. Trendlines can also be useful in identifying breakouts from a trend that is about to change direction.

Examples of short-term trading strategies

There can be many examples of short-term trading strategies. Here, we will show two: scalping and swing trading.

Scalping example:

Scalpers take quick trades, so they focus on 5-minute and 1-minute charts. You can see a 1-minute chart below showing stochastic oversold and overbought signals. A scalper could have used those to make quick profits from the market. Each of those trades would have lasted a few minutes. Please note that this is just an example, not a tested strategy.

Short term trading strategy scalping

Swing trading example:

Take a look at the Nasdaq price chart (D1 Timeframe) below. You can see that the trend is up, with the price bouncing off the trendline at intervals. A swing trader can decide to trade the impulse price swings after each pullback to the trendline. The trade entry method would be an oversold signal from the stochastic plus the price hitting the trendline. In the chart, you can see that each time the price hit the trendline, the stochastic gave an oversold signal. Another confirmation for experienced traders is the reversal candlestick patterns that form at the trendline (circled).

Short term trading strategy (swing trade)

Short-term trading fees

There are a number of fees that should be taken into account when short-term trading. They include the following:

  1. Spreads: These are differences between the bid and ask prices. They are already accounted for in the instrument’s buy and sell prices and will appear on your order ticket when you enter their values.
  2. Commissions: These are fees the brokers charge for executing trades on your behalf. You pay trading commissions when you enter and exit a trade. The commission rates vary from broker to broker and may also vary with the country from where the share originated.
  3. Holding costs or overnight fee: Any trades held overnight, such as in swing trading or other similar strategies, will incur holding costs. These are tallied at the end of each day and are determined by the appropriate holding rate for the instrument you have

Short-term trading indicators

The most effective technical indicators for short-term trading strategies are those that can help traders define entry and exit points over a shorter period. Although technical indicators should not be used exclusively and should be combined with other trading tools to achieve the best possible results and analysis, the following are a few examples of effective indicators that are commonly used for short-term trading:

Moving averages

Traders can use moving average strategies to determine whether the price of an asset is rising or falling, which is useful information to have. A simple moving average (SMA) typically uses a timeframe of approximately 10-20 days when analyzing short-term trends; however, this can be modified to reflect the timeframe you wish to analyze.

When an asset’s price is rising, the moving average will start to slope upward. That may be an indication to buy the asset. On the other hand, when the price is declining, the moving average would point downward, which could be an indication to sell short. 

Relative strength index

The relative strength index (or RSI), can be used to determine whether a security is overbought or oversold. It measures a security’s relative strength or weakness in comparison to the strength or weakness of other market assets. Generally, a reading of 70 indicates that the asset has been overbought, while a reading of less than 30 indicates that the asset has been oversold.

Divergence, failure swings, and centerline crossovers on a trading chart can all be used to generate buy and sell signals for short-term trading. For example, some traders may choose to buy on a decline when the RSI shows an oversold condition or bullish divergence and sell on a rally when the RSI shows an oversold condition or bearish divergence. 

Stochastic oscillator

A stochastic oscillator can be used to determine whether or not a financial instrument has a good value based on the closing price range of the instrument over a short period. When the stochastic lines fall below 20, it indicates that the instrument has reached an extreme level of overselling, which may be a signal to buy the asset.

On the flip side, when the stochastic indicator lines are above 80, it indicates that the asset has been overbought, which may prompt a trader to liquidate their position. The stochastic indicator can also be used to anticipate short-term shifts in the direction of an existing trend as part of a divergence strategy.

Pros and cons of the short-term strategies

Pros

  1. They provide the opportunity to make quick profits.
  2. You have the option of reinvesting any profits.
  3. You can avoid some of the inherent risks of holding a position overnight
  4. Capital requirements are reduced
  5. If you are good, you can use leverage and grow faster

Cons

  1. The risk of a loss is more in short-term trading (compared to long-term investing)
  2. It is unquestionably more stressful, and dealing with it requires a specific psychological makeup
  3. You are effectively tethered to your computer screen due to the increased time commitment
  4. You must become acquainted with the fundamentals of technical analysis to succeed
  5. You are playing a zero-sum game – most traders lose money

A few years ago we wrote an article that might help you find out if short term trading is for you (or not):

Short-term trading and taxes

Long-term and short-term investments are taxed differently, and you should take note of this as a trader. Short-term trades are taxed at the same rate as regular income, whereas long-term investments (trades held for more than one year) are taxed at a lower rate. 

The taxpayer’s ordinary income tax rate determines the portion of the proceeds from the sale of an asset that is exempt from taxation when the asset was only held for a short period. Depending on their income and how they file their taxes, traders may be subject to taxes ranging from 10% to 37% for their short-term trading profit. Long-term rates are usually between 5% to 15%.

As always, please get in touch with a tax advisor in the country where you reside. Each country has its own taxation system.

Short term trading strategy backtest

We have thus far given you several examples of how you can develop a short term trading strategy. However, none of them are quantified. In this section of the article, we’ll make a specific trading strategy with trading rules and settings that you can backtest yourself.

Let’s end this article with three specific backtests with trading rules. One backtest is performed on S&P 500, and one is on DAX-40.

Stock market index trading strategy backtest – Nasdaq 100

In August 2021, we shared our preferred trading approach for Nasdaq-100/S&P 500 trading with our members. This strategy, Volatility Swing Trade Nasdaq/S&P 500, has proven to be highly effective, and we are reluctant to release the trading guidelines for free. We firmly believe that this strategy is too valuable to give away.

To showcase its success, please refer to the equity curve presented below, demonstrating the strategy’s outstanding performance:

Short term trading strategy example

The strategy’s trading performance, statistics, and metrics is summarized like this:

  • No. of trades: 178
  • Average gain per trade: 1.73% (2.76% for winners and -2.31% for losers)
  • Win ratio: 80%
  • Profit factor: 3.3
  • CAGR/annual return: 13.1%
  • Exposure/time in the market: 11%
  • Max drawdown: -19.5%
  • Risk-adjusted return: 121% (CAGR divided by time spent in the market – 13.1/0.11)

Do you worry about recessions? It doesn’t matter:

Short term trading strategy performance

The strategy performed very well during recessions, as in 2000-2003, 2008, and 2022. For example, during the bear market of 2022, the strategy had 14 trades and five losers, but the overall gains were still impressive at 7.9%. We can assure that it feels great to make money when the stock market goes down!

Stock market index trading strategy backtest – DAX-40

We traded multiple European markets in the past, but we have now limited our trading to exclusively DAX-40 futures.

Initially, we had some favorable outcomes when trading Italian MIB futures. However, we soon recognized that the notable correlation between European markets posed a significant challenge, and we consequently decided to narrow our scope. It is important to note that European stock markets generally exhibit a high degree of correlation. When trading DAX-40, one must exercise caution to avoid overlapping trades with other indices such as EuroSTOXX 50.

We have presented, so far, a couple of trading edges in DAX-40 for our annual trading edge subscribers (but more will come). The DAX is an impressive trading vehicle that trades and moves differently and somewhat independently from the S&P 500, and it hence offers some diversification benefits to your portfolio of trading strategies. Most strategies that work in the US don’t work in Europe – and that is very good.

Both monthly edges in DAX are overnight trading strategies that hold the position for less than 24 hours. Below, we present these two DAX strategies backtested with statistics, historical trading performance, and metrics.

We buy at the close of the stock market session (1730 local German time) and exit the next day at 0900 local time when the stock market opens. Because the DAX futures contract trades almost around the clock, you’d need to adjust the settings in your trading software to accommodate when to buy and sell.

Stock market index trading strategy backtest – DAX-40 (1)

As mentioned, the strategy is exclusively for our paying subscribers; thus, we don’t want to reveal the trading rules. However, we provide you with the equity curve below:

Short term trading strategy DAX

The statistics reveal that there were 172 trades made that made an average gain of 0.2% per trade. This sizable margin provides significant protection against any commissions and slippage incurred. The win rate was 64%, and the profit factor was 1.9.

This is a strategy we have been trading live for many years, and it’s still working pretty well. Click here to access the strategy.

Let’s look at our second DAX-40 backtest:

Stock market index trading strategy backtest – DAX-40 (2)

Just like the first DAX-40 backtest, this is also an overnight strategy. Let’s go straight to the equity curve:

Short term strategy example in DAX

Again, this is a decent strategy where the 303 trades have generated an average gain per trade of 0.23%.

Click here to access the trading rules of the strategy.

Stock market index trading strategy backtest – DAX-40 (combined)

The combined strategies have the following equity curve:

Short term trading strategy trading rules

Our assertion is that these strategies are reliable and exhibit profits and losses that are not correlated with the overall direction of the market, which is precisely what one would desire. Making money trading stock market indexes is possible, but you need to be disciplined and systematic.

FAQ

What are the best strategies for short-term trading?

There are no best or worst in trading – as long as it works. There is only one way to determine if something works: to backtest. Alternatively, you can build your track record.

Which indicator is best for short term trading?

There is no definite answer; it also depends on what kind of market you are trading. For example, overbought and oversold are less likely to work in forex than in the stock market.

Short term trading for beginners – how do I start?

Do yourself a favor and spend a lot of time reading and studying before you start. It takes years to become a doctor, and don’t expect to be good at trading – ever. You are just as good as your last trade.

What is the best time frame for short term trading?

We believe the best time frame for short term trading is daily bars. You can even day trade by using daily bars.

Can you make a living from short term trading?

Yes, we do, and we have for over 20 years. But the fact is that the majority LOSE money, let alone not make a living. The best advice is to get a job, invest, or trade on the side, and you’ll do fine. You can do very well by spending one hour per day trading.

What strategy do most traders use?

The most popular trading strategy is probably any mean reverting oscillator that signals overbought or oversold conditions. This could be the RSI indicator, for example. It’s popular, and it’s also one of the most useful.

Which strategy is most accurate?

There is no accurate strategy. Most strategies lose frequently, but that’s fine. It’s all about having a positive expectancy.

You must either have a high win rate that recoups a few big losers or a low win rate strategy with more prominent winners than losers. Trading is a numbers game!

Which indicator do most traders use?

We believe the most used indicator is the Relative Strength Indicator. It’s also a pretty useful one!

List of trading strategies

We have written over 1300 articles on this blog since we started in 2012. Many articles contain specific trading rules that can be backtested for profitability and performance metrics.

The trading rules are compiled into a package where you can purchase all of them (recommended) or just a few of your choice. We have hundreds of trading ideas in the compilation.

The strategies are taken from our landing page of different examples of a short-term trading strategy.

The strategies also come with logic in plain English (plain English is for Python trading and backtesting).

For a list of the strategies we have made, please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:

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