Consolidation brings disappointment for most of the directional traders. There is not a lot of trading opportunities especially for a time frame of 3-4 days. This makes all of us traders a lot eager to take a trade as soon as we see the indices pushing beyond the range it has been trading.
Problem with this trading is that such potential breakout may take a lot of time to materialize. There may be more than one attempts before the breakout can materialize. Let us look at how to deal with such potential breakouts.
A non-trading tactic that every trader must have is to adjust the behavioural aspects of trading.
1. Small Commitments: The idea here is that the attempted potential breakout may be a failure, and such failures may keep coming in till we see a success. To ensure that we do not run out of money till the last attempt is made, we need to ensure that the bets are smaller than usual so that the same capital as well as loss provision can get us more attempts to trade.
2. High Reward to Risk Trades: The choice of trades in such markets also matter. This is because one needs to be adjusting the smaller capital to large rewards to accommodate for more failures than usual.
Yes, each one of us want High Reward to Risk trades only. But this is about choosing the strategy for the same. Remember, such inherently high reward to risk trades will always have compromised success ratio.
Example, Call Option compared to a Futures Buy will always have a better reward to risk ratio but the success ratio for Buy Call will always be lower for various reasons.
Now that this is out of the way, let us jump to the strategy that works well in such scenario of potential breakout.
Characteristics of such market is that it may explode if the range gets broken sustainably. However, it might just turn around and give a small blow that pushes the stocks and indices back into the range again.
Traditional Strategies like Buy Future will not work here because of the blow back into the range that can push us out of business in 2-3 failed attempts.
Strategies like Buy Call/ Put will also not be so effective. This is because of the time factor which could go to 2-4 days. Also, the big throw back into the range could get the Option completely wiped off.
Best Suited Strategy can be time bound (2-3 Days) Back Ratio Spread.
Example of Call Back Ratio Spread for Bullish Break-Out
With stock at 1400 we sold 1 lot lower strike Call and bought 2 calls of a higher strike
The grey line shows pay-off after 2 days. Interestingly, no matter how hard the stock falls the risk is around 2500, but even a 4% move gets rewarded by 4X+ the same amount.
This works if there are more than 10 days to expiry, so in last few days of expiry go for next expiry.
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 decision.
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