The optimum profitable scenario involves the erosion of both the time value and the intrinsic value of the put and call options. In the event the market does pick a direction, the trader not only has to pay for any losses that accrue , but they must also give back the premium they have collected.

The only recourse short straddle traders have is to buy back the options they sold when the value justifies doing so. This can occur anytime during the life cycle of a trade. If this is not done, the only choice is to hold on until expiration. The option straddle works best when it meets at least one of these three criteria:.

Analysts can have a tremendous impact on how the market reacts before an announcement is ever made. Prior to any earnings decision or governmental announcement, analysts do their best to predict what the exact value of the announcement will be. Analysts may make estimates weeks in advance of the actual announcement, which inadvertently forces the market to move up or down. Whether the prediction is right or wrong is secondary to how the market reacts and whether your straddle will be profitable.

After the actual numbers are released, the market has one of two ways to react. The analysts' predictions can either add to or decrease the momentum of the actual price once the announcement is made. In other words, it will proceed in the direction of what the analyst predicted or it will show signs of fatigue. A properly created straddle, short or long, can successfully take advantage of just this type of market scenario.

The difficulty occurs in knowing when to use a short or a long straddle. This can only be determined when the market will move counter to the news and when the news will simply add to the momentum of the market's direction. There is constant pressure on traders to choose to buy or sell, collect premium or pay premiums, but the straddle is the great equalizer.

The straddle allows a trader to let the market decide where it wants to go. The classic trading adage is "the trend is your friend. Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors.

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Trading Rules Identify the nearest resistance level in the 5 minute or 15 minute timeframe. Also identify the nearest support level in the 5 or 15 minute timeframe. About 1 minute before the news is released, place a buy stop pending order pips above the resistance line.

Also place a sell stop pending order pips below the support line.

Straddle trades are so called because they have two separate legs that sit either side of a given price level. More often than not, straddle trades are used to trade breakout events. As such they are short duration technical plays. In either case the premise is simple. The straddle has two order-legs and each of these can trigger if the price hits that level. As long as you have the ability to go both long and short in a market at the same time, a classic straddle trade system can be devised.

As I show later, there are workarounds when your broker has a no-hedging policy. In the article I look at ways of tackling the challenge of whipsaw. My Excel spreadsheet is also available for free download if you want to try out this strategy. The straddle is a form of hedge trade. The hedging is such that a 2-leg system has a fixed maximum loss but an unlimited upside. The buy stop order will trigger only if the price rises to at least 1. The sell stop order will trigger only if the price falls to at least 1.

In this example only one of my trades executes and this is the buy stop order. This happens because the price took more or less a straight upwards path. The order executes between ticks 1 and 2. The scenario is shown graphically in Figure 1. The next example shows a loss scenario. I am using the same starting point as the first example. But here the price initially falls then rises again so that both the buy and the sell order are triggered.

Once both orders are triggered the system is locked in at the maximum loss amount. This happens at tick 6 as shown in the table below. My straddle leg was 50 pips. So in this case the system fixes at a loss of 50 pips and once both trades are open and remain open this cannot change. As the table shows, from tick 6 onwards the PL of the straddle system does not change, regardless of what happens to the price. Rather than executing both trades when the loss outcome is certain, you can perform a close-and cancel.

As explained in my articles on grid trading , you can do this if the price is highly likely to meet both levels. This ebook is a must read for anyone using a grid trading strategy or who's planning to do so. Grid trading is a powerful trading methodology but it's full of traps for the unwary. This new edition includes brand new exclusive material and case studies with real examples. This is done to save trading fees. Ideally we would not open the second order because the loss is already defined at this point.

With close and cancel , the open position is closed and simultaneously the pending order is cancelled. Note though because the order must be cancelled a few points away from the trigger level, there is a small chance that the price will actually reverse. So overall the profits or losses using close and cancel will not be the same as a classic straddle, though they should be close. One of the things that make straddle strategies appealing is that they have a well-defined risk and reward.

This helps with the trade plan. Figure 3 below illustrates the various payoffs click to enlarge the image. The maximum loss in the 2-leg straddle trade is the distance between the legs. So for example if the distance between them is 50 pips, this is the worst case payoff and the maximum risk. The point about being clear and decisive is a tricky one. This is because important market events such as FOMC policy meetings and other high impact announcements often contain a lot of information.

It takes a while for the market to digest and assimilate it all and this can cause a lot of volatility see below in the interim. If volatility is high you could find your orders triggering before the event you are trying to trade.

It will also be harder to find meaningful levels on which to place the straddle. Whipsaw happens most often when the market is assimilating new information. It can give rise to ferocious swings of price that will trigger both sides of the straddle. Whipsaw is also very common on range breakouts and the breaching of important support or resistance levels.

However the most aggressive movements are usually during important economic announcements. The first option is to use narrow profit targets on each of the straddle orders. This approach does alter the outcome. This happens because one leg of the straddle can close independently of the other. You will therefore have to place stop losses on both orders so as to limit downside. Examples of this are central bank announcements and sometimes on nonfarm payrolls. See Figure 4 click to enlarge image.

When strong whipsaw is expected a better strategy is to reverse the trade orders. This works as follows:. The sell limit order will fire once the price touches the upper leg of the straddle. The buy limit order will trigger once the price touches the lower leg of the straddle.

This approach has a better payoff in highly volatile situations; namely when whipsaw price movement is expected. The reverse straddle system will have a maximum profit equal to the leg distance. Without stops it has unlimited downside. Though as with most strategies the devil is in the detail. The first point to note is that if your broker prohibits hedging you will need to modify the strategy slightly.

Generally, as explained above this can be overcome with only a minor change to the strategy. In extreme cases, brokers will freeze quotes altogether, effectively barring trading around the release itself. In other cases, the spreads can be widened so much that it makes it difficult to make any profit. Download file Please login Finally, you can also create very effective straddle systems using options.

Start here Strategies Technical Learning Downloads. Cart Login Join. Home Trading Learning. Straddle trading strategy © forexop. Copyright © forexop. Figure 1: Example 2-leg straddle trade with profitable outcome © forexop. BEST SELLER. Figure 2: Example where straddle reaches maximum loss © forexop. Figure 3: Profit and loss outcomes in 2-leg straddle system © forexop. Figure 4: Classic whipsaw price action taking place around an ECB policy statement © forexop.

Download file Please login. Crisis Investing: Making Money from Market Chaos To reach the level of a profitable trader there are two opposing views: To specialize or to diversify To Specialize or Diversify?

To reach the level of a profitable trader there are two opposing views: To specialize or to diversify How to use Pyramid Trading to Build on Winners Pyramiding is a trading system that drip feeds money into the market, gradually as a trend develops The Bat Pattern: Harmonic Chart Trading Bats are five point chart patterns that can point towards either a bullish or bearish breakout. Fading the Fakeout — How to Trade Against False Breakouts A fading strategy bets against any move that takes the price out of a normal range.

Another way of putting Basic Rules for Trading the Harmonic Butterfly The butterfly is a harmonic chart pattern which you can use to trade possible trend reversals. Short Squeeze and Long Squeeze: Trading Methods A squeeze is where the market is moved to an extreme value in a short space of time. These moves are Leave a Reply Cancel reply. Leave this field empty. Contact Us Timeline FAQ Privacy Policy Terms of Use Home.

Figure 4: Classic whipsaw price action taking place around an ECB policy statement © forexop. This is because important market events such as FOMC policy meetings and other high impact announcements often contain a lot of information. If the price goes wild in either one of the directions, chances are your winners become less than losers. For the sell stop pending order, place its stop loss pips above the resistance level. If volatility is high you could find your orders triggering before the event you are trying to trade. Grid trading is a powerful trading methodology but it's full of traps for the unwary.

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