Make these three adjustments to your trade to improve risk-reward profile

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As COVID-19 pandemic turns the entire market more headline-driven than driven by solid economic data. The moves upward or downward become vulnerable to reversals and respite.

Such is a case after recent moves where a struggle with 200-300 points of a sticky round number of 9000 is making many of us doubt the sustainability of the current gains.

While no analytics could add an element of the slightest amount of predictability to the headlines on this unknown, there certainly are instruments and trade adjustments using such instruments that can at least put predictability on the maximum drawdown that one has to be ready for while trading the ongoing trends.

This adjustment is to have a conjoining trade along with the existing trade that is aimed just to improve your Risk: Reward profile.

It wouldn’t necessarily mean creating a Hedge as it is always looked at as a mechanism just to stop from bleeding further.

This is because the trade adjustments we are talking about are not only associated with restricting further losses but also at locking profits as well. We need to look at it as more of a preconceived sequence of trades that keeps you in charge of the drawdown at all times.

Many would refrain from trading into a market like this where the potential winning and losing percentage are at a mismatch (Considering the proximity to recent top).

So instead of stopping the trade, take all the opportunities that you would have taken to trade just keep the trade adjustments in mind at all times.

Just like hedge though, these trade adjustments would also:

a. Always come at a cost which is irrecoverable

b. Would alter future cash flows rather than past

Adjustment #1:

Let us say one already has a directional position outstanding regardless of either cash or futures. The position starts incurring losses. Now many of us (including me at times) would not be willing to exit at our predefined level.

But, when it comes to taking that bit of extra more risk beyond calculation, take an offsetting position in options. Buy a Put against Longs or Buy a Call against Short.

Result:

The position won’t create any big disaster and we would still be in the around just in case the position turns favorable after hitting the stop loss.

Adjustment #2:

This conjoining trade would occur when we are sitting on an already profitable trade. In that case, instead of mulling over whether or not to book profits, take a cost to create an opposite position in the option and sit on it keeping the upside open at the same time locking accrued yet not realized profits.

Finally,

Adjustment #3:

For every trade taken after realizing the commotion at the Top, have a big heart and create a trade at the beginning only with a conjoining opposite position in Options so that at the cost of that option premium, all we need is to just track profits, do not track losses.

(The author is CEO & Head of Research at Quantsapp Private Limited.)

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

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