The active trading of securities offers individuals many ways of engaging the marketplace. Scalping, swing trading and long-term capital investment are all valid methods of pursuing profit through the buying and selling financial instruments. Falling somewhere on the spectrum between swing trading and long-term investment is the discipline of position trading.
Position trading is a strategy where traders and investors aspire to capitalise on strong pricing trends through entering and remaining present in a market for an extensive term. A position trade is a commitment of both time and money, with the intention of realising a sizable gain from the sustained growth of an open position's value.
Elements Of A Position Trade
In contrast to day trading, position trading is an intermediate to long-term approach to the marketplace. The typical duration of this type of trade is measured in weeks, months and years. Instead of implementing an intraday perspective using seconds, minutes and hours, decisions are made referencing daily, weekly, monthly and yearly timeframes.
Successful trading is dependent upon many factors, with each style having unique elements crucial to its effectiveness. In position trading, there are a few aspects of function that are essential to the viability of the approach:
- Market Entry: In any trading strategy, entering the market in a controlled, consistent and structured manner is a critical part of achieving sustainable profitability. Because of the extended duration of a position trade, market entry decisions are predominately made according to fundamental analysis. While technical analysis may be used to refine an entry point, accounting for the importance of macroeconomic factors is a major part of identifying a product's long-term growth potential.
- Trade Management: Actively managing an open position in the marketplace can be a daunting task. Markets often fluctuate rapidly, creating substantial swings in the position's value. A management plan that defines when and how to exit a trade is crucial to physically realising a profit or taking an appropriate loss. Many strategies are available to manage trades, including trailing stops, break-even scenarios and scaling out of a position.
- Money Management: Identification of assumed risk and potential reward can be the most important aspect of a trade's viability. Position trades are to remain active in the market for a relatively long time, so the potential payoff from taking a higher degree of systemic risk must be considerable. There is no steadfast rule in how large of a profit must be aspired to, but a 1:3 risk vs reward ratio is a common target.
It is important to remember that the primary goal of position trading is to capitalise on a strong trend. Identifying opportunities with adequate risk vs reward ratios, in addition to entering and exiting a market efficiently, are imperative to the success of the approach.
Advantages To Position Trading
While the optimal duration of a position trade depends upon several factors unique to each specific product, holding an open position in any market affords traders and investors several inherent advantages:
- Trend Capitalisation: Taking a position in a market for an extended period of time enables the trader to catch robust trends created by evolving market fundamentals. For instance, an announcement by the European Central Bank (ECB) regarding the future of monetary policy for the European Union (EU) may cause a precipitous rise or fall in the value of the euro (EUR). A trader that is long or short the EUR/USD at the time of the announcement may have the opportunity to gain from an ensuing trend in the EUR/USD market.
- Mitigate "Noise": "Noise" is a term used to describe short-term volatilities unrelated to the overriding market direction. Noise can wreak havoc upon short-term trading approaches, frequently stopping out winning trades prematurely. Position trading greatly reduces the impact of noise, because trade management parameters associated with larger timeframes are able to withstand pressure created by short-term volatilities.
- Limited Maintenance: In comparison to intraday trading styles, position trading is a relatively hands-off approach. After the due diligence related to market entry has been completed, and a trade management strategy is in place, the only task that is left is to periodically monitor the situation. The time allocation necessary for position trading is limited, much less than a day trading or scalping methodology.
The advantages of position trading appeal to a wide array of individuals. People who do not have the time necessary to trade on an intraday basis find position trading a great way of engaging the financial markets. In addition, many traders prefer to make infrequent decisions and avoid getting caught up in the periodic turbulence intraday trading often provides.
Disadvantages To Position Trading
While the logic behind the implementation of a position trading strategy is alluring to some, there are several unique disadvantages. As stated earlier, taking a position for a considerable period of time is a commitment. Getting "cold feet" and making an unplanned, early exit from the trade may serve to compromise the integrity of the entire strategy.
Listed below are several drawbacks to the practice of position trading:
- Exposure: While it is true that holding an open position in a market for a longer period does increase the chances of catching a trend, being exposed to the market itself is inherently risky. Systemic risk is the danger of a sector or entire market undergoing a severe correction. Remaining active in a market for long periods of time increases the chances of experiencing heightened degrees of volatility related to systemic risk.
- Consider the example of the ECB making a monetary policy announcement regarding interest rates facing the EU. If the announcement is unprecedented or a major shock to the currency markets, then a dramatic restructuring of market-related fundamentals is possible. The valuations of not only the EUR/USD may be thrown into chaos, but the entire currency market.
- Account Liquidity: Taking and holding a position requires a trader or investor to allocate capital for a substantial period of time. The initial capital outlay—the money required to facilitate the transaction (including margin requirements)—is effectively off the table until the position is closed out. This can lead to sustaining noticeable "opportunity cost," where the trader or investor is unable to pursue other opportunities because sufficient risk capital is not available.
- Lack Of Compounding: Position trading is conducted on an infrequent basis. Gains from each trade are realised upon the position's close, which can be weeks, months or years from the date of market entry. Accordingly, those profits cannot be reinvested back into the market until the position trade is closed out. This severely limits the ability to compound returns in a timely manner.
The disadvantages to position trading are worth consideration. Tying up risk capital for an extended period can come with great opportunity cost, both in terms of missed trades and the inability to compound returns. In addition, the psychological impact on the trader can be extensive as position value fluctuates, or as an unforeseen development shakes up the marketplace as a whole.
As with seemingly everything in the financial arena, the strategy of position trading comes with upsides and downsides. Many individuals find the possibility of realising sizable gains through catching a trend attractive, while others are leery of being exposed to the possibility of a widespread financial collapse.
The decision of how to engage the markets lies within the individual. While position trading is a great fit for some, it can be a detriment to others. The responsibility for selecting an optimal trading methodology also lies with each aspiring trader or investor. If the appropriate time, capital and personality is present, then a strategy of position trading may be ideal.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. Friedberg Direct will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.