Trade Types
The following trade types are essential to a trader's success. In live markets, conditions shift through choppy periods, rallies, and sell-offs, and each trade type can offer distinct advantages depending on the environment.
For example, say you have a directional trade (e.g., a long position in AUD via futures) but want to manage some of the volatility tied to USD exposure while maintaining the AUD position. You could turn this into a relative value trade by selling a currency highly correlated with AUD, such as NZD. This would create a long AUD/short NZD position, effectively removing the USD exposure and allowing you to capture relative movements between AUD and NZD.
1. Directional Trades
Goal: Profit from the absolute movement in the price or yield of a single asset.
Example: If you believe U.S. 10-year Treasury yields will rise due to expected rate hikes, you might take a short position on the bond, betting its price will fall (since bond prices move inversely to yields).
Focus: Only on the anticipated direction (up or down) of the asset.
2. Relative Value Trades
Goal: Profit from the difference in value between two related assets, regardless of whether markets as a whole move up or down.
Example: You might buy U.S. 10-year Treasuries and sell German Bunds if you expect U.S. yields to rise more slowly than German yields. Here, the focus is on the relationship or spread between the two, not the overall direction.
Focus: Exploiting pricing discrepancies between two assets expected to revert to a normal relationship.
3. Mean Reversion Trades
Goal: Profit from assets that have moved away from their historical average prices or yield spreads, assuming they will return (or “revert”) to the average.
Example: If a particular bond’s yield spread has widened more than usual compared to its historical range, a trader might bet it will narrow back toward the mean. This often applies to relative value trades where mean reversion within spreads is anticipated.
