Conquer market turbulence by trading outperformance

F&O Cues

Shubham Agarwal

Although we have not broken the sequence of higher highs and higher lows in the short term, there is a bit of laziness observed in the market. Especially in the last move down of about 500 points from ~21500 in Nifty. We have come up again and gained newer highs which also gives a bit of fear of height.

Such factors make you think of an alternative strategy that lets you trade with open arms yet be a little safe from any big shock. We can not forget at any time that this is the year of once in 5 years events of union elections also.

That brings us to the best alternative strategy of all time. Call it Long-Short or Pair Trade or simply Outperformance trade. Let us understand the trade logic first and then the trade setup.

Trade Logic:

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.

2 Kinds of factors affect any stock.

Systematic: Factors affecting the country or sector as a whole (Policy Decisions, Interest Rates, Geo-Political Risks).Unsystematic: Company Specific Factors (Result Miss, Fire at Plant, etc).

By taking care of systematic factors, we can largely remove the risk of a big drop in the overall market. To remove this risk, we can create a combination of Buy & Sell positions in Futures.

Buy a Pvt. Bank Future

Sell another Pvt. Bank Future

Factors positive for both or negative for both will have very little impact on your Profit/Loss because they will get neutralized. This trading technique aimed at removing systematic risks popularized in the 1990s in the world of Financial Derivatives.

With the struggle around higher levels, these are times when one wants to Buy for Outperformance and Not Bargain Hunting. Stocks that either run faster or fall at least.

Trade Setup:

We always have a stock that we are interested to Buy. Just follow these steps to convert to an outperformance trade.

Find another stock from the same line of business that

1. Has Highs and Lows around the same period as Our Stock in the past

2. Has outperformed (Risen more / Fallen Less) Our Stock in the recent past (around a month)

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

We would anyway have a stop loss on Our Stock. Just keep that stop loss in mind. If the stop loss gets triggered, get out of the 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 but if the outperformance comes in and we do hit the target it would give a fantastic reward for the risk taken.

I do not say that only trade outperformance, but it is always helpful to keep this as one of the minor shares at least in our trading portfolio at all times.