Remove uncertainty, trade pure outperformance with long-shorts: Shubham Agarwal

F&O Cues

Global uncertainties along with the upcoming result season does put a bit fear in the minds of traders. This is more of a concern especially when the trend has not been a friend. Choppy moves may keep the indices doing ups and downs in a 1000-point window.

A situation like thiscalls for a trading strategy that gives some immunity to the ongoing uncertainty. Imagine having a trading strategy that is neither bullish nor bearish. Such that you may not have to worry about the direction of the market or the stock at all.

The trade is called Long-Short. Made popular in late 1990s in North American markets, Long-Short has been a go-to solution for traders in times of indecisiveness. The strategy revolves around risk removal.

Before we get into that let us understand the types of risk that a stock holds.

Systematic Risk: Factors affecting Country or Sector as whole (Policy Decisions, Interest Rates, Geo-Political Risks).

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Unsystematic Risk: Company Specific Factors (Result Miss, Fire at Plant etc).

Now, systematic risk is equal for everyone. It affects all stocks more or less in the similar fashion. We can find better similarities in behaviour of 2 stocks to a systematic risk, if we have both the stocks from the same industry.

For Example,

Buy a Pharma Future
+
Sell another Pharma Future

Factors positive for both or negative for both will have very little impact on your Profit/Loss because they will get neutralized.

The biggest hurdle to trading turbulent market is the risk of a drop. Outperformance trade removes the risk of a big fall. Let us understand how that happens.

How To Trade?

Deploy a scanner to find a stock that you are interested in Buying or Selling. Just follow these steps to convert to outperformance trade.

For a bullish trade, find another Stock from the same line of business that,

1. Has Highs and Lows around the same period as Our Stock in past
2. Has outperformed (Risen more / Fallen Less) Our Stock in recent past (around a month)

Then just Buy your Stock, Sell the Stock found that satisfies above mentioned 2 conditions.

Similarly, you want opposite set up for the Sell stock to be paired for a Long-Short trade. So, for 2nd condition, you sell your stock and Buy the one that has already fallen or has had a less of a pull back from the fall.

What is the exit strategy?

We would anyways have a stop loss on Our Stock. Just keep that stop loss in mind. If the stop loss gets triggered, get out of the entire combination. If the trade works out and our Stock heads up and hits the target, then the Profit could be a little less because the stock we sold may also go up.

However, generally it is seen that the money lost is small, so if the outperformance comes in and we do hit the target it would give fantastic reward for the risk taken.

This may not be the universal strategy but it does work best while the times are uncertain.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.