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We can classify trading strategies followed by all types of traders into two broad categories as directional trading strategies and non directional trading strategies. Both strategies require different types of approaches, different levels of market knowledge and different trading requirements.
Directional trading strategies are trading strategies which include taking long and short positions in market. Traders profit when the prices of instruments in which he take long positions rises and when the prices of instruments in which he take short positions drops. Most of the trading strategies practiced by common traders are directional trading strategies. Some common examples of directional strategies are trend trading strategies, breakout systems, moving average cross over strategies and pattern recognition strategies.
Non directional trading strategies, on the other hand, are market neutral strategies. The trader does not take any net long or short positions; instead he matches his positions smartly. Most non-directional trading strategies are complex strategies which require very good automation and pre-defined trading rules. These strategies are for expert traders and big players. Some common examples are sector matching strategies, pair trading strategies, arbitrage strategies and stock matching strategies.
Advantages of directional trading strategies include,
1. Most of them are simple and flexible, so that any kind of trader can follow.
2. They can be used to trade all kinds of financial instruments – stocks, options, futures, funds, bonds, currencies, commodities, all.
3. They need less automation and technical analysis skills.
4. The basic idea is to go long in an uptrend and to go short in a downtrend.
5. Traders can use basic risk minimizing tactics like stop losses and position offsetting.
The disadvantages are; most of them can only be practiced when market is trendy, there is higher downside risk and position sizing limiting, also traders are limited with their risk minimizing tactics.
Advantages of non-directional trading strategies include,
1. They suit you, if you are a large-scale trader with high position sizes.
2. Most of these strategies demand calculated diversification, which is a good risk minimizing tactic.
3. Trades are done according to pre-determined strategies thus less human interfere (and emotion) involved.
4. Traders can limit their trading risks in may ways – traditional and innovative.
The disadvantages are; not suitable for all types of instruments and markets, require complex trading system and good market knowledge, and require extreme money management.
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