Elements of a trading strategy.
There are several key elements that need to be included in every trading strategy and traders need to consistently apply all of these elements on every trade.
A trader may have multiple strategies, based on varying market conditions, but no matter the market conditions, a few things must be included.
Market analysis for expected movement and the time frame for that movement, trade entry criteria, money management, an exit plan for both loss levels and take profit levels, and finally, the post-trade analysis to learn from both successes and failures.
By the way, the last point may in fact be the most important as it can be extremely valuable in helping to improve all of the other elements of the strategy.
What’s your exit strategy?
The post trade analysis may be the most overlooked aspect of a trading strategy. Probably the second most overlooked element, particularly by new traders, is having an exit strategy for both loss levels and take profit points.
On the loss side, frequently inexperienced traders are known to let their losses run far too long in the hope the market turns in their favor and they can be right.
Once it runs to far, hope turns to fear and then they are stuck. On the profit side, the market may be running in their favor and excitement turns to greed, only to have the market reverse and find themselves giving back some if not all of the hard earned profits.
This is one part of the strategy that Nadex Call Spreads can assist with.
Because of the floor to ceiling structure, with both maximum risk and maximum potential profit baked into the contract, natural target levels for both sides of the trade are established.
So let’s take a look at a couple of basic strategies:
Strategy #1 - The long position.
In this strategy, a trader believes the market is going higher and therefore would be a buyer of the contract.
With call spreads, there are multiple ranges and multiple time frames for each market.
In the case of buying, traders, in order to maintain the most favorable risk to reward ratio, will look to find a contract where the underlying market is in close proximity to the floor. By doing so, they may pay a bit higher premium, however, they have a lower defined risk based on the floor, and more potential upside as the ceiling of the contract is farther away.
One key element to this strategy to consider as well is time and not just price. For example, you may be looking for a large move in the US 500. You have one contract #1 that is trading 2 points, or $20 above the floor, with a potential upside of $60, but it is expiring in just 40 minutes.
Or, you may have contract #2, which is trading 2.5 points or $25.00 above the floor, with a potential upside of $55, but has 6 hours remaining to expiration. In this case you have a choice and will need to consider if paying slightly higher time premium, but for that premium, receiving a substantially longer amount of time for the trade to work and potentially push farther into profit over 6 hours than it potentially could in 40 minutes.
There is not necessarily a right or wrong answer, as each trade is unique to the market condition and expected move, but something always worth considering.
Strategy #2 - The short position.
This strategy is effectively the inverse of the previous strategy.
In this case a trader thinks the market is going down and therefore would be looking to sell the contract.
Now, the ceiling becomes the level of risk protection and the floor becomes the ultimate profit objective. So, when selling, traders will often look to sell close to a ceiling in order to maintain the favorable ratio of risk to potential return.
Also, as with the previous scenario, time is an element that needs to be considered in addition to outright price levels in relation to the floor or ceiling.
This was a basic overview of some simple call spread strategies. For more in-depth strategies, register for upcoming webinars or view our extensive webinar archive covering everything from basic to advanced strategies for all Nadex contracts.
What to read next:
- What are call spreads?
- How to get started with call spreads
- Call spreads trading strategies
- Call spreads educational courses