Beyond Buy and Hold: Advanced Trading Strategies Explained

Imagine this: you hear that a stock is crashing. Your immediate thought would be that everyone is losing their money, right? But what if I told you that some traders are actually profiting when stocks go down?

I’m sure you’ve heard of buy and hold strategies, where investors purchase stocks and keep them for years, waiting for their value to grow. This is a great long-term approach and can often outperform even the most advanced trading strategies over time. But investing isn’t just about buying stocks and hoping they go up.

Some traders use more advanced strategies not only to profit in different market conditions, but also to reduce risk and protect their investments. Let’s break down some of the most common ways they do it.

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Short Selling: Betting Against a Stock

Short selling (commonly referred to as “shorting”) is when traders bet that a stock’s price will go down instead of up. There are 2 main steps:

1. A trader borrows shares of a stock from a broker and sells them at the current price.

   
   

2. The stock price drops, they buy the shares back at a lower price and return them to the broker, keeping the difference as profit.

   
   

   OR

   
   

   The stock goes up instead, they lose money because they have to buy it back at a higher price.

   
   

Example:

A trader shorts a stock at $100, borrowing it and immediately selling it on the market for $100. If it drops to $80, they buy it back and make a $20 profit per share. But if it rises to $120, they lose $20 per share.

• Risk Level: High – If the stock skyrockets, losses are potentially unlimited.

  
  

Options Trading: Betting on the Future

Options are contracts that give traders the right (but not the obligation) to buy or sell a stock at a specific price before a certain date. The two main types are:

• Call Options – A bet that a stock will go up (the right to buy at a fixed price).

  
  

• Put Options – A bet that a stock will go down (the right to sell at a fixed price).

  
  

Example 1:

A trader buys a call option for Apple stock at $150, expiring in a month. If Apple’s price jumps to $170, they can buy at $150 and immediately sell for $170, making a profit.

Example 2:

A trader buys a put option for Apple stock at $150, expiring in a month. If Apple's price drops to $130, they could buy Apple stock at $130 on the market and use the put option to sell it at $150, locking in a profit from the difference.

Explanation

For a call option, if the stock price rises above the strike price (the fixed price agreed upon in the contract), the buyer would then exercise their right to buy the stock at the lower strike price, and you must sell it to them. The seller loses value there, as they are forced to sell their stock for less than it is worth.

Remember that options are a right not an obligation. That means if the price goes down, falling below the strike price, the buyer would NOT exercise their right to buy the stock at the strike price, as it would be more expensive than the market value. Therefore, the buyer loses the premium they paid for the option. The premium is the price the buyer pays to purchase the option contract. This premium is a form of compensation to the seller for taking on the risk. Even if the option is not exercised, the seller keeps the premium as profit.

For a put option, if the stock price falls below the strike price, the buyer would then exercise their right to sell, and you must buy the stock at the higher strike price. The same rule applies here. If the stock price rises above the strike price, the buyer would not exercise their option, as they would be selling their stock at less than market value. In this case, the seller of the option would simply just keep the premium.

• Risk Level: Low-Moderate - For the buyer, the risk is low because they can only lose the premium paid for the option, while for the seller, the risk is slightly higher because they may have to fulfill the contract at an unfavorable price.

Futures Trading: Predicting Prices Ahead of Time

Futures contracts let traders agree on a price today for something they will buy or sell in the future. These contracts are commonly used for commodities (like oil, gold, coffee, and wheat) but also apply to stocks and indexes. They can also be used to hedge risk by allowing companies to lock in prices for commodities or assets they rely on, reducing uncertainty about future costs.

Example Starbucks, which is highly dependent on coffee prices, can use coffee futures to lock in a fixed price for coffee beans. This way, even if coffee prices rise in the future, Starbucks will pay the agreed-upon price from the futures contract, protecting themselves from price fluctuations. This strategy helps companies manage financial risk by providing price certainty and reducing volatility, which is generally pretty bad for businesses.

When you enter into a futures contract, both parties are obligated to buy or sell the asset at the agreed-upon price and date, unlike options, where the buyer has the right but not the obligation to execute the trade.

• Risk Level: Depends– Futures can have varying risk levels depending on how they're used:

  
  

  Hedging to Reduce Risk (Starbucks Example): Companies (like Starbucks) use futures to hedge risk by locking in prices which reduces the risk of fluctuations, ensuring they know their costs in advance and are protected from sudden price hikes. This type of use is considered lower risk because it helps manage uncertainty.

  
  

  Speculation with High Risk (Stocks): On the other hand, futures can be used for speculation, such as betting on the price movement of stocks or other assets. If the price moves in the opposite direction of the trader’s position, the losses can be huge. Speculating with futures has high risk because the potential for significant gains or losses is amplified.

Margin Trading – Borrowing Money to Trade

Margin trading is when traders borrow money from their broker to buy more stocks than they can afford. This can increase profits but also lead to bigger losses.

Example

A trader has $1,000 but borrows another $1,000 to invest $2,000 in stocks. If the stock rises 10%, they make $200 instead of $100. But if it drops 10%, they lose $200 instead of $100.

• Risk Level: Very High – If the trade goes bad, the trader still owes the borrowed money.

Arbitrage – Profiting from Price Differences

Arbitrage traders make money by taking advantage of price differences in different markets.

Example

A stock trades at $100 on the New York Stock Exchange but $101 on the London Stock Exchange. A trader buys at $100 and sells at $101, locking in a risk-free profit.

• Risk Level: Low to Moderate – Usually low risk, but competition is high, and profits are small.

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In conclusion, while traditional buy-and-hold investing is a great long-term strategy, there are many advanced trading methods that can help traders profit in different market conditions and reduce risk. Each strategy covered above offers a unique way to navigate the market, but they come with different levels of risk. Whether you're looking to protect your investments or make big bets on price movements, understanding the risks and rewards of each method is key. Always remember to do your research and only use strategies that align with your risk tolerance and financial goals.

While these strategies can be valuable for more experienced traders, if you're a beginner, it's best to focus on learning the basics of investing first. Without a solid understanding of the market, they can lead to significant losses. Start by building a strong foundation with safer, long-term investment strategies, and only consider more complex tactics as you gain experience and confidence in your investing knowledge.

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Is there another strategy you thought we should've covered in this article? Let us know down below!