Directional trading is the usage of a trading strategy that looks at the considerable direction the investor seems to think the market may go. The investor's overall outlook for the way forward in the market will predict how the investor will buy or sell. When looking at directional trade the only option put into consideration or under scrutiny is the direction of the market, nothing else.
How does a directional trade work?
We have already determined that directional trading requires a forecast in the direction a market may go. Now we will have a look at the ways in which this works. There are only two ways of making a profit through directional trading and that is buying and selling an asset. To make a profit from a trade your predictions on the direction of the market have to be correct. For a guided prediction it's important to look at trends in the market, which will include assessing the history of past months, weeks, days and even hours. When looking at these trends, what you are looking for is the following:
- How do the trends look in agreement or disagreement with each other?
- Are the assets you are looking to oversold or overbought
- Do you see a support or resistance trend in the market?
It is vital not to get distracted by too many indicators as there are a lot of other options to consider. When we look at the trend forecast our main concern is direction and time. Taking into consideration that anything less than a month is short term. 1-2 months is intermediate and anything more than 2.5 months is long term. The preferred range to consider for directional trading is often intermediate as a pose for the short term.
For a directional trade to be of use you need to know of the stock of a company for example, when they pay out their profits or when the company will share details on their annual performance. The direction of the stock, what the price will be and what the time period all determines whether you will profit or lose.
Why use options for directional trading?
Using different options for directional trade allows for a trader to create leverage opportunities through the different options at their disposal. The more options traders have, the greater the possibility of minimizing as much risk as humanly possible. Traders get an opportunity to have their views shared on timing or trading ranges when open to more options. Also, if the volatility is lower that means that the leverage becomes higher from all the options the trader has on his side.
Other available options for trading directional trade include credit-and-debit-spreads, which are mostly used when traders want to be extensive in entering the direction of the trend. When choosing this option, the trader cannot change the direction of a price when it is for a long-term period. The only options available for selection are either varying strikes or expiration dates.
With-debit spreads, the trader is permitted to go with the-risk-of-a long-term option and by doing so lose only a portion of the risk through converting it-into-a debit-spread. Debit spreads - allowing the trader to use directional set-ups on-stocks - where long-term options have come to be pricey and the risk too high to bear.