Defining directional trading
One of the many strategies in investments includes directional trading. It is a strategy that depends on the investor’s perspective about things in the future, such as the financial market as whole or single security. The decision to buy or sell depends on the investor’s assessment of these things that we have mentioned. In short, it’s all about the direction.
In the topic of options trading, we can almost always also encounter directional trading. Why? Many strategies apply when capitalizing on the up and down movements in a particular stock or the whole market. Hence, directional trading can be translated into betting on the up and down movement of a market or security. Investors can apply this strategy by taking long positions on a market or security rising or is expected to rise. On the other hand, they take a short position if a market or security is declining or about to decline.
The size of the movement
When dealing with directional stock trading, it is not that profitable if the move is not that significant. If the move is not that big, then the trader might not be able to pay all the commissions and fees. It may be possible, but the profit may be zero or significantly less. We want to exert effort for nothing, do we? This is the reason why we always encounter directional trading when options trading is involved. Options trading gives directional trading a chance with the leverage involved, regardless of the anticipated move’s size. It is nothing like stock or index trading, which is always relative to long or short trades.
Now, we already established that this strategy is mainly focused on directions or movements. However, wise traders do not stop there because trading is always unprecedented. So, there should always be a plan B or a risk reduction and mitigation management if the odds did not favor the investor.
Under the directional trading strategies
The term “call” refers to a person’s right to buy an underlying asset in trading. This term’s other counterpart is called the “put,” which means the person’s right to sell the asset. There are different types of direction trading strategies involved in options trading that apply call or put combinations. The basic types are bull calls, bull puts, bear calls, and bear puts.
Let us summarize
The directional trading strategy is based on how the trader sees the market’s or security’s future movement direction. The trader can take a long position if the market or security is rising or expected to rise and a short position if it is declining or expected to decline. The trader should have a strong faith and conviction about his future view of the market or security’s movement direction. However, there should always be a consideration for risks. There should be a plan if the direction goes oppositely. Directional trading is very prevalent in options trading because it gives a trader more flexibility but lesser risks than security purchases.