Last Updated on May 25, 2022 by Neera Bhardwaj
Trading is not just simply buying and selling an asset. Different traders bank on different strategies and positions depending on their capital structure and risk appetite. Thus, to milk profits from trading, meticulous planning and in-depth knowledge of technical analysis is a must.
But another common and widely popular strategy is positional trading. Let’s understand what positional trading is and its applications in markets.
Table of Contents
What is positional trading?
Positional trading is a strategy wherein you do not square off your position the same day or within a few days. After you invest, you hold on to your investment for weeks, months, or even years, intending to earn maximum returns.
Positional traders follow the ‘buy and hold’ strategy for different reasons. For example, they could be result announcements, or a company could be filing for bankruptcy.
Hence, these traders are not impacted by short-term volatility and have a long-term horizon with ample liquidity.
Pros and cons of positional trading
Like all trading strategies, positional trading also has its share of pros and cons.
Pros of positional trading
- You don’t have to monitor the market continuously.
- Short-term bearish trends and volatilities do not affect the profit-generating potential of your investment.
- You can use multiple trading strategies to generate the maximum possible returns.
- Positional trading uses both fundamental and technical analysis to pick out quality stocks, thus ensuring good returns.
Cons of positional trading
- If the market trend reverses for the worse, you might suffer losses.
- Liquidity is compromised with a long-term horizon.
Why do investors prefer to do positional trading?
The answer to this question is simple. Positional trading has helped investors build massive amounts of wealth. A fundamentally strong stock may underperform or be beaten in the present scenario due to innumerable factors.
If the investor does not hold such stocks for the long term, he could then stand to lose a good opportunity of wealth creation. Also, if the investor finds the daily ups and lows of a stock risky, positional trading can be a preferred option.
Effective positional trading strategies
Though there are various strategies that you can use for positional trading, some of them have stood the test of time and can deliver good returns. The strategies are as follows:
The support and resistance strategy
The most commonly used is the support and resistance strategy. It helps investors gauge the price band within which the stock is moving.
The support level is the lowest price level (for a particular day or trading session), and it indicates a position where there is a buying pressure on the stock. On the other hand, the resistance level is the highest price, which is indicative of selling pressure.
The support and resistance levels help determine if the stock price is expected to enter a downtrend or an uptrend, hence letting you effectively decide the right point to enter a stock and vice-versa.
The breakout strategy
The breakout strategy is closely linked to the support and resistance strategy. It is used when stock prices break their support or resistance levels. The stock price is then expected to create another support and resistance level.
For instance, if the price breaks the support level, it would be expected to fall further and create a new support level. Similarly, if the price breaks above the resistance level, it would be expected to increase further and create a higher resistance level.
When a support level is broken, the market segment is perceived to be negative, pushing traders to short their positions. On the contrary, when a resistance level is broken, traders prefer to long their position.
Hence, effectively using a combination of breakout and support/resistance strategies, a trader can earn stunning returns.
The EMA crossover strategy
Many traders use simple moving averages to predict price trends. But for more relevant and accurate predictions, traders have now shifted to exponential moving averages. Instead of using just the average of prices, exponential average assigns weightage to each day end price, with relevance to most recent data.
Once plotted on a chart, EMA lines are generated (for desired no. of days) that track the price movement.
The most commonly used are 50-day and 200-day EMA (Exponential Moving Average). The interaction of these two EMA lines is studied to identify trading strategies. The intersection and divergence of the lines (50-day EMA and 200-day EMA) help predict the price momentum.
- If the 50-day EMA line crosses the 200-day EMA line from below, the point of intersection is called the golden cross. This indicates a bullish run where the stock prices are expected to increase.
- If the 50-day EMA line crosses the 200-day EMA line from above, the point of intersection is called a death cross. This indicates a bearish run ahead wherein the stock prices would fall.
RSI and stochastic RSI indicator
The EMA strategy, though helpful, is a lagging strategy. It shows the trends after they have already happened. By the time you react, a trend reversal might have happened thus nullifying the return-generating potential of your investment.
Hence moving averages are used together with Relative Strength Index (RSI) and stochastic RSI for more accurate predictions.
RSI is a technical tool that helps in pointing out overbought and oversold levels for a particular stock. Stochastic RSI indicator, also an analytical tool, on the other hand, works on the principle that the closing price of a stock is correlated with its swings – upwards and downwards. For example, if a stock closes at a high, it could be indicative of an upward trend and vice versa.
Both these technical overlays can be an excellent tool to understand not just the market sentiments but also entry/exit positions, momentum strength, and trend for a particular stock. RSI is technically read through with points that are pointed out as levels. The most commonly used range on an RSI is 30/70.
If the RSI on a particular stock moves below 30, it is indicative that the stock is in a bear momentum, thus making for a good entry position.
And if the RSI moves above 70, it depicts a bull momentum, making a good exit point. RSI indicators also use 20/80, 90/30 levels, interpretation same as above.
Pullback and retracement strategy
Lastly, the pullback and retracement strategy is also helpful in identifying good positional trades. Pullbacks are short periods of corrections that happen when the market is in an upswing.
Investors use these periods to plan their entry into the market so that they can buy at a low price and sell high. When the pullback happens, and the prices fall, investors enter the markets and open their positions.
The Fibonacci retracement strategy
Fibonacci retracement is a mathematical sequence that makes use of 3 ratios – 61.8%, 38.2%, and 23.6% to predict trend and price momentum.
Based on the principle that stock would retract to these ratios, charts are then drawn using the highest and the lowest prices of a stock.
The Fibonacci retracement lines are also drawn on the price chart to identify the support and resistance levels.
Stock markets are unpredictable and thus not understanding its nuances can harm your capital and be akin to gambling. A smart trader will use the strategies and tools available to him to earn strong returns, despite a volatile market. It is also important to understand what trading strategy and risk would suit your current requirements.