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Trading Model

In general, there are 2 models that commonly used by Market participants for trading, and investing in Market

• Stop and Reverse, trend following model (S&R).
• Option selling Model.

Let's elaborate some hidden facts of these models.

A. Underlying Instruments :

In S&R Model, Useful in Cash, futures, and Option buying.

While in Option selling model, only Options of index and liquid stocks use as underlying.

B. Probability Set up :

S&R model has different systems and set ups having low probability with High Risk reward Ratio. Generally good systems have 30-50% probability set up.

Option selling model has High probability set up, in general it has average 60-70% probability set up. As it's probability is on higher side, Risk reward is on lower side.

C. Risk management theme :

In S&R model, it's system based exit and entry rules apply. So, system is back tested and optimised and Risk defined before application of system.

In Option selling model, Risk is unlimited, so Only focus made on Risk management. In S&R model one trade that multifold your capital, so all focus put on this one winning trade. While in Option selling model, One trade that Ruin your capital, so all focus made on this one losing trade.

In S&R model, pre defined Stop order is there, as it is Low probability set up, number of losing trade is more than winning trades. So it's exit is also well defined and system based.

While in Option selling model, Risk manage by adjustment and Roll over. For adjustment it requires extra capital to manage risk. So, Option selling requires higher capital to manage Risk, in compare to S&R model operate by smaller capital also.

D. Return :

In S&R models, Return is much more higher than Option selling models. As Return is pre defined in Option selling, so return is limited to credit receive by option selling.

There is co-relation between Probability and Return. If you increase your probability your return would decrease, and if your probability is decrease your return would increase.

But in Option selling model , there is more consistency in return in compare to S&R model.

E. Pyramiding Vs Diversification :

In S&R model, mainly based on theme of run your profit longer and cut your losses early. It's focus mainly on winning trades, so add more and more capital as your trade run on winning direction, it's called pyramiding. Here you centralise your capital mainly in winning positions. As it is low probability set up, so you found less winning trades in compare to total trades. 2nd in sideways trend you even get lesser winning trades in compare to clear Bull or Bear trend. So, It's dificult to deploy larger capital.

In contrast to that, In Option selling model, to control Risk, you have to diversified your capital to manage your position size. As it's high probability set up, there are more number of trades available to deploy capital. And in all market conditions, up trend, down trend and even in sideways you get similar set up to deploy larger capital. So, it is best used for managing large size Capital.

F. Types of System :

S&R is purely system based trading model, while Option selling is more of Discretionary system with system based application.

As both system used by large number of market participants, it's necessary to understand it's inherent property as well as peculiarities.