Fixed trading strategies cannot adapt to the market. You could wear the same tee shirt everyday but at some point you will sweat and that shirt is going to smell. That’s stale, boring and risky. You should probably adapt your clothes washing routine to the weather.
Dynamic trading, as the name suggests, is trading using strategies which quickly adapt to such changes. This may mean, including new, more recent data in your analysis for your trades. This could also involve changing your strategy or adjusting its parameters as seems appropriate. You could change your shirt AND shine your shoes too.
Example – Assume that my love for Elon Musk, his future plans for Tesla Inc and my financial analysis has made me bullish on the Tesla stock for the coming few weeks. The stock has been swinging quite wildly and this volatility is expected to continue.
Strategy:
Buy Tesla at the start of the trading session every morning and sell it when it reaches a high.
But how do I set my profit target and stop loss? Let us say I check the range in which stock has remained for the past week. A 5 day average tells me that the stock moved by 150 points intraday (High – Low). I shall set my profit target 150 points above the share price at the start of the session and my stop loss 150 points below. So if the price at the start of the session is 900, my target will be 1050 and stop loss will be 750.
Adaptive component:
The extent of volatility is likely to change over the coming days. What change can I make to try and maximise my winnings? I can make the trading range dynamic. The 5 day average will be updated to include the latest trading session and exclude the oldest one. The average will therefore, move with the market and my profit target and stop loss levels too.
Other examples of adaptive components:
– Dynamic technical indicators (7 day moving average vs 20 day moving average)
– Rolling statistics such as correlations (say, 20 day moving average since relationships between two securities can change over time)
– Trade amount (1% of my account balance. If I’m making more money, I can afford to place bigger bets!)
A related term is Dynamic Hedging (more popular). It’s the same concept, used in risk management, where you actively adjust the hedge for a position.
