This is a form of pairs trading and is usually referred to as a box trade. It involves placing two opposite trades on the same instrument at the same time; one long and one short. This is in contrast to the traditional pairs trade, where you long one stock and short another on the basis that they are out of their normal trading range relative to each other. Here you are waiting to gain a sense of market direction and as soon as this becomes clear you would close the losing trade and let the profits on the winning trade accumulate. This system is somewhat controversial as usually for most cfd trades there is a need for market analysis.
You may be wondering when it will be appropriate to take such a trade. After all, it’s going to cost you more in fees to do this than if you selected the winning trade and only took that. The answer to this is in the timing of the trade. The fact is that you are losing on one trade as much as you are gaining on the other, up till the time when you liquidate the losing position. In other words, it is equivalent to waiting for the breakout and then placing a trade in that direction, and many traders choose instead to do this.
What this doesn’t take into account is the spread between the bid and ask, and how it may be affected by circumstances. If the price becomes volatile, then you can expect the bid-ask spread to increase, and by making your trades before the volatility strikes, you keep that part of the trading cost down to a minimum. This presupposes that some event will happen that will shake up the security and cause a big movement, the direction of which is not predictable. Under these very specific circumstances, then the box trade may make sense.
So you are looking not only for a stock that is trading sideways within a limited range of prices, but also one where you expect something to happen which will cause a strong reaction in the price. It would not make sense to be sitting on a long trade and a short trade unless some activity was due to occur — after all, the interest that you receive on the short CFD position is at a much lower rate than the interest that you will be paying for the long CFD position, and to spend much time holding onto both trades would eat away at any profit that you expect to make.
Typically this would occur when you know that an important announcement is to be made, but cannot get a sense of whether it is a positive or negative event that will be disclosed. Usually the rumour mill will give some indication, so that you have a clue which way the price is going to move. But sometimes, as we’ve discussed before, even good news can cause a drop in price if the market has anticipated it, or shares can rally on disappointing results if worse was feared in the run-up. While it’s not a common occurrence, sometimes you just might find that a box trade provides you with the answer to your question.