Market Neutral Strategy: Staking The Odds in Your Favor

Copyright (c) 2007 CashFlow Avenue

Is there a trend in stock and option trading?

Let's start of by defining a trend. A trend is simply the general direction of the market. The market can only move in 3 directions - up, down or sideways. It is as simple as that.

For directional traders, knowing the trend is important because that is how money is made. If there is no trend, then how would the buyer of the uptrend profit when the market moves sideways. They need to buy low and sell high. Likewise, short sellers can only benefit when they sell high and buy back lower. Trend followers will always wait for the market to shift or turn before jumping in. Directional trading, like any trading strategy, requires discipline and patience. Directional traders can only benefit when the market moves in their direction - up or down.

Directional trading demands strong self-discipline to follow precise entry and exit rules. Successful traders utilize strong risk management systems that use current market price, portfolio allocation system in an account and takes advantage of market volatility. Directional traders use an initial risk strategy that determines their capital exposure at the time of entry. This means that they must know how much to buy or sell based on their account size. On the other hand, adverse price movements may lead to an early exit for their entire trade for a small loss. To be a successful directional trader, the risk reward ratio should be 1:3 for any trade to be worthwhile. That is because despite the technical tools available, directional traders are wrong most of the time. If they are profitable 4 of 10 trades, then they can be considered as excellent traders. Directional traders have the market odds staked against them every time that they enter into a trade. So when they are right, they have to let their profit run, and when they are wrong, they must quickly cut their losses fast.

Before entering into any trade, any trader must already consider the below.

Price: One of the first rules of directional trading is that price is the main concern. If a market is at 50 and goes to 47, 49, and 46 - the market is in a down trend. Sometimes technical indicators can show otherwise. There are many different indicators that can supposedly show where the market should move. While that is always a nice tool, successful traders should only be concerned with what the market is doing, not what the market might do. The price tells you what the market is doing - not the indicators!

Money Management: The most critical factor of any trading system. Successful traders will already have a money management system is place. Money management ensures that the traders will always be in business despite a bad spell. Good traders will lose money. Bad traders lose more often. Whatever you trading level, a good money management system will prevent a wipeout of your portfolio.

Risk Control: How much can you afford to lose in a trade if it goes wrong? That must be determined before any position is opened. Setting your rules upfront will curb emotional and irrational decision making. For most traders, emotional decisions can almost certainly be the worst decision that they make. Knowing what to do before trouble come knocking will help keep you on your toes.

Any trader should already know the below questions before entering into a trade.

How and when to enter the market?

How many contracts or shares to trade at any time?

How much money to risk on each trade?

How to exit the trade if it becomes unprofitable?

How to exit the trade if it becomes profitable?

While trading trends can be extremely profitable, the odds are unfortunately staked unfavorably against the directional traders, even more so for directional option traders due to time decay. A relatively unknown but superior trading strategy does not forecast nor predict market movements exist - a Market Neutral Trading Strategy. Prediction is impossible in the stock market. The Market Neutral Strategy is certainly not a holy grail. It is not some passing fad or hyped-up secret trading strategy. It is the strategy that takes full advantage of the depreciation of options premium as it approaches expiration. Markets may move up, down, or even sideways for this strategy to be profitable. If you must trade everyday, the market neutral trading strategy will not work for you. A sound trading strategy should only limit you to 3 to 6 trades per month which should provide decent returns of up to 10% per month. With all the discipline and rules of a directional trading strategy applied, the market neutral strategy can be used to devastating effect.

What do you need to get started?

An active mind, willingness to learn, strong discipline and passion to succeed.

No knowledge of what is happening in Shanghai or the ability to read financial statements is required. The key is the price on the chart.

Discipline and common sense to do the right thing.

About ten minutes a day to check on all open positions.

A reliable PC/Notebook and internet connection.

Trading is a zero-sum game. For every winner, there is a loser. If you are tired of losing in the market, then it is time to arm yourself with Market Neutral Trading Knowledge.