Advanced Strategies Unveiled

4-minute read

Advanced technical strategies allow traders to elevate their existing knowledge to new heights. In this lesson, we explore the concept of advanced strategies, focusing particularly on hedging.

What is an Advanced Trading Strategy

An advanced trading strategy is a sophisticated approach that builds upon basic trading rules. Unlike simpler strategies, these systems consider a wider array of data and signals to determine optimal entry and exit points in the market.

Traders may pursue more complex strategies for several reasons: to improve upon existing methods, explore new markets, or simply challenge themselves. Advanced strategies often involve managing multiple positions simultaneously and using intricate indicators and patterns for decision-making. They may also employ complex instruments such as options, which are generally avoided by beginners.

However, a more complex strategy isn’t always superior. Simplified strategies can sometimes yield comparable results. It’s crucial to balance the time investment against the potential returns.

If you’re new to trading, consider starting with our beginner’s course to grasp the fundamentals.

Introduction to Hedging

Hedging is an advanced technique involving multiple positions to mitigate potential losses from adverse price movements. This strategy is sophisticated because it requires managing various trades and understanding market correlations.

The concept is straightforward: if a primary position is at risk of losing value, an additional position is opened to offset potential losses. Derivatives like CFDs, options, or futures are commonly used in hedging, leveraging their ability to cover potential downturns in underlying assets.

For example, if you hold shares in a company and anticipate a market downturn, you might short the stock using a derivative. This short position would gain value as the stock’s price drops, offsetting losses in your shareholding.

Understanding Delta in Hedging

The effectiveness of a hedging instrument is gauged by its delta, or hedge ratio, which measures the correlation between price movements in the underlying asset and the derivative.

A perfect hedge, where risk is entirely neutralised, is rare. Most hedges aim to limit rather than eliminate risk. It’s also important to note that hedging isn’t cost-free; additional trades mean higher costs. Traders must decide whether the expense of hedging is justified compared to the potential risks.

Hedging Example

Imagine purchasing 100 shares of Company ABC at £20 each. To hedge against potential losses, you buy a put option with a strike price of £18, expiring in a year. The option costs £1 per share, totaling £100. If ABC shares rise to £30, the option expires worthless, resulting in a £100 loss from the premium. However, the shares’ value increases, leading to an unrealised profit of £900 after accounting for the premium.

If the shares fall to £10, you can exercise the option, of selling the shares at £18 each, thereby mitigating the loss. This example illustrates how hedging can reduce financial risk, even if it doesn’t always prevent a loss entirely.

In our next lesson, we will delve into more advanced strategies, including various options strategies.