Directional vs non-directional trading are two different trading approaches. Each of which has its pros and cons. Remember that in trading, the market could go either up, down, or sideways. Do you think you will profit if the market goes up or down? Or do you think it doesn’t really matter? Learn the difference between directional and non-directional trading. It will help you decide which approach is suited for you based on your risk tolerance, trading style, and knowledge of the market condition.
What Is Directional Trading?
When you say directional trading, it simply means following the trend.
Think of it as taking a position based on the current market trend. You choose a position either up or down and make a profit depending on the market trend going upward or downward. You make money if you take an upward position and the market goes up. You lose your money if it’s the other way around.
As they say, no one can predict the market. You can study the charts, apply different approaches, and follow the rules yet the market can still go against you. You should be aware that sudden reversals in the direction of the market will put your profit at risk.
What Is Non-Directional Trading?
In non-directional trading, whether the market goes up or down you can still make a profit. However, you will lose money once the market does not move. With a non-directional approach, traders aim to profit from market inefficiencies, volatility, or relative price movements. You have to watch for triggers or catalysts for market movement. This could be in the form of:
- Business merge
- The hiring of new top management
- New Product Launching
- Approval of patents
- Announcement of financial earnings
If you are going to take the route of a non-directional trader, you can use the straddle approach. On the same stock, you buy a CALL option and a PUT option. With this strategy, you are taking both the bearish and bullish position. Unlike directional trading, where you are taking a single option. With nondirectional, you are buying two options thus the price risk is higher.
Would you consider non-directional to be less risky than directional? For most people, yes. This is because you are not dependent on the market’s direction. However, it’s not as easy as it sounds. This trading approach requires a deeper understanding of trading strategies and several factors.
Examples of Directional vs. Non-Directional Trading
To illustrate the differences between directional and non-directional trading, let’s take a look at some examples:
Example 1: Directional Trading
For example, you are positive that stock ABC, currently priced at $100 per share is going to go up by $150 in the next quarter. You then buy 300 shares at $100, putting a stop loss at $80. If the market goes up and the price reaches $150, you earn gross profit.
Another example, let’s say you think that the Euro will appreciate against the US dollar. You then take a long position in EUR/USD. You bought 100,000 EUR/USD at 1.2000 with a stop loss at 1.1900 and a take profit at 1.2200.
From the examples above, you make a profit since the Euro appreciates over the dollar. However, if it was the other way around and Dollar appreciates over Euro, you will incur a loss.
Example 2: Non-Directional Trading
For this example, let’s say that you decide to use the straddle options strategy to profit from a large price movement in either direction. Remember that with this strategy, you will make a profit once the spot price is either bigger or smaller than the strike price.
You decide to buy a call option and a put option at the same strike price of $250 for a total cost of $50. The market moved up, and the call option you placed is profitable. If the market goes down, the put option will be profitable. But, if the market does not move either up or down, you will lose the $50 cost of the options.
Conclusion
Now that you know the difference between directional and non-directional trading, will you follow the market trend to try and make a profit? Or do you think you will be more comfortable with the straddle option?
You can try both directional and non-directional trading approaches. In the former, you go where the trend is. While with the latter, you go with the market’s volatility. See which one works for you best.Whichever approach you choose, make sure to manage the risk you are taking. Take time to study and learn more about trading.
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