Rule based Trading Strategy – A Traders GuideLast Updated Date: Apr 30, 2022
Check out everything about Rule based Trading Strategy here.
There are as many trading strategies available for Traders. Choosing a trading strategy or style depends on several factors, primarily on whether a trader is a subjective or an objective trader.
Objective trading strategies follow pre-defined rules and are therefore called rule-based trading strategies.
On the other hand, subjective trading strategies may rely on factors such as a trader’s gut instinct, opinions formed through personal or other people’s experiences.
Subjective trading may also be a mix of calculation and dependence on individual judgment or assessment of a situation.
Beginner traders may often find it difficult to rely purely on judgment-based or opinion-based strategies.
Rule-based trading strategies come in handy because they are predefined and based on strictly chalked-out rules.
A rule-based trading system defines a trade set-up and lets a trader know exactly what the position size will be, the risks, and the profits involved.
Since rule-based strategies are precise, they lend themselves to machine-based tools and applications well.
Rule-based trading may be categorized into a trading system that is automated, manual trading strategies, and a combination of automated and manual trading strategies.
Rule-based trading constitutes nearly 50 percent of the total trades on both exchanges, BSE and NSE.
Rule based Trading Strategy
Here are some of the most important rule based trading strategies –
Position Sizing – Rule based Trading Strategy No.1
A key element of trading is how the position is managed under varying circumstances, and this can depend on various factors.
However, when a rule-based trading system is used, there is no question of bias or subjectivity, and the position size is based on preset commands given to a machine.
Stop Loss – Rule based Trading Strategy No.2
Protecting profits is an important aspect of trading and this can be done by using the stop-loss strategy.
A rule-based system helps manage risk by altering stop loss based on stock movement.
So, if the price of a stock is at say, Rs 10 and the stop loss is at 9.5, and the stock price goes up to Rs 13, then the stop loss level too goes up.
Thanks to a rule-based trading system, trading in large quantities becomes easy because the risk is managed in an auto mode.
Identification of Trends – Rule based Trading Strategies No.3
Rule-based trading strategies help traders identify trends or reversal trends early on. These are based on factors like volume, price, resistance, and support.
One of the most often used trend-based strategies aligned with rule-based trading strategies is the momentum and trade-based strategy.
This strategy uses current and historical price data to assess if a trend is likely to continue or reverse.
Instructions can be set in a manner wherein the tool/machine is preset to buy or sell shares based on one moving average period falling above or below another defined moving average period.
Arbitrage Strategy – Rules based Trading Strategy No.4
An arbitrage strategy may be used when there is a difference in the price of securities on different exchanges.
This strategy can be leveraged by the machine to spot arbitrage opportunities; so when a stock is at a lower price on Exchange A and the same stock is at a higher price on another, the machine spots the difference and executes a trade.
Advantages of Rule based Trading
One benefit of rule-based trading is that it minimizes the possibility of errors when judgment-based or emotion-based trading strategies are used.
Another benefit is that a trade is executed at the optimal price and placement of an order is quick and has fewer errors. Also, defining reward or risk is relatively easy with a rule-based trading strategy.
Rule-based strategies can also be backtested, which means using historical data to reconstruct trades that would have taken place in the past by way of rules in a certain strategy.
The result of the backtesting helps to understand how effective the strategy is.
Rule-based trading is ideal for a beginner trader who may be vulnerable to emotions clouding decision-making.
It is also ideal for a new trader or someone who has a busy schedule to allow precise rules to help decision-making and take away the stress that comes with the vagaries of the markets.
Experienced traders may use a combination of rule-based trading strategies and subjective trading strategies, armed with the right tools and adequate knowledge of the various concepts of trading.
Rule based Trading Strategy – Conclusion
Rule-based traders can gain access to new-age technologies that help them execute trades in an efficient manner, minimizing the possibility of errors.
All they need to do is access their Angel Broking demat trading account and check out SmartStore, a one-stop solution that has all the applications and tools to help them get started with rule-based trading. What’s more, traders can also gain knowledge by way of many resources and learn concepts through a peer group.
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