Stock trading has always been popular in the trading and investment world, and the stock market will always be a dynamic and exciting place for those who know how to navigate it. If you are a stock trader who has been trading the financial market for a while, you may be looking for more advanced strategies in which you can hone your skills. In this article, we look at 2 advanced stock trading strategies for experienced traders who want a challenge. They are short selling and options trading.
Before we begin, it is essential to reiterate that these strategies are only as useful as the trader is skilled. The stock market is ultimately unpredictable. Not only is there no guarantee of success, but there is also a possibility of incurring losses. You should never trade more than you can afford to lose, and if these strategies are proving to be more complex than you can handle, you should not attempt to use them in live markets.
Short selling is a strategy that involves borrowing shares of a stock from a broker or another trader and selling them. Traders take this approach when they have an expectation that the stock will decline. After the trade sells the stocks they borrowed, they wait for its price to decline before buying them back, and then returning them to the broker or loaner. The profit is the price difference between the sale price and the buyback price.
An example of short selling
Say you are a trader who believes that the stock of a company is currently overvalued. You expect it will decline, so you borrow 100 shares from a broker at $50 per share. You sell these shares worth $5,000 on the market, generating cash. If the stocks of the company do depreciate and fall to $45 a share, you can buy back the 100 shares with only $4,500. The $500 difference will be your profit.
Benefits and risks of short selling
The benefit of short selling is that it can be a great way to find opportunities in the market when you anticipate share prices will fall. This is because the principle of short selling is the same as traditional buying and holding, only the directions are reversed.
However, short selling is a high-risk strategy. This is because there is no limit to how high the price of a share may go, if it appreciates instead of depreciates. The higher a share price rises, the greater your losses. This can lead to a potential of (theoretically) unlimited losses.
For example, if the stock price of the company you had borrowed 100 shares and sold appreciates to $60 instead, you will be forced to buy back the shares for $6,000. This will lead to a loss of $1,000.
Options trading is a form of derivatives trading that can used in the stock market. An option is a contract that gives the contract buyer the right, but not the obligation, to buy or sell a certain quantity of stocks within a specified period, at a predetermined price. Stock options are popular with investors for their flexibility, as these options can simply be left to expire worthlessly should the market not perform to expectations and the trader does not want to exercise the option.
Traders purchase an options contract with a small sum of money called a premium. They can then specify the direction in which they want to speculate, depending on how they think the stock market will move. If they believe share prices will increase, they will buy a call option. If they believe share prices will decrease, they will buy a put option.
If the markets behave according to their expectations, they can exercise the option and make a profit by buying or selling the asset at lower or higher prices respectively and pocketing the difference.
An example of options trading
A trader who believes the share price of a stock will increase will buy a call option. Let’s say they purchase 100 shares of a company’s stock with a strike price of $60 per share, and the contract is due to expire in one month. The trader pays a premium to set up the contract.
If, at the end of the month, the share price of the stock increases to $70 per share, the trader can still purchase the 100 shares at $60 per share and sell them immediately on the market. This will generate a profit of $10 per share, or $10 x 100 = $1,000 for the 100 shares.
If the share price of the stock does not increase or decreases to $50 per share, the trader can simply do nothing and let the contract expire. This way, they only lose the premium paid for the contract, and nothing more.
Benefits and risks of options trading
The main benefit of options trading is the flexibility offered to traders. Traders can find opportunities in both rising and falling markets, and when the market does not perform as expected, they can forfeit the option and the maximum loss they will incur is the price of the contract – or the premium.
However, there are also risks that come with options trading. Namely, that it is more complicated than traditional buy and hold strategies, as it involves negotiating the options contract. Traders must also understand the mechanics of options trading and the idea of speculating on the stock market movements, before participating in options trading.
If you are keen on exercising these two strategies, below are two solid trading tips you should consider. They are working with a demo account and having a strong understanding of the stock you want to trade, before you begin.
Trade on demo before going live
These stock trading strategies are more complex than the traditional buying and holding, and they can be more difficult to grasp. Therefore, traders should use a demo account to practise trading with these strategies before they go live. Not only can they understand how to gain a solid grasp on the market, but they can also minimise the risk of incurring losses on live markets.
Have a strong understanding of the stock you are trading
Traders who use these advanced strategies to trade stocks should not only spend their time mastering the strategies. They should also devote time to understanding the price movement of the stock they want to trade. This means knowing what moves the price of the stock, from industry news to interest rates and other supply and demand factors.
Short selling and options trading are both popular trading strategies that many stock market participants use to find opportunities. It is important to note that with these more complex strategies comes higher risks. You should make sure you have a strong understanding of these techniques as well as the stock you are trading before attempting to go live.
Additionally, traders will also find that they can use these above advanced strategies on markets beyond the stock market. Many traders trade commodity and currency options, and they short sell a variety of assets. This increases the flexibility and usability of these strategies, once you have mastered them.