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To many, trading stocks is all about making a single buy of a stock, waiting for it to reach your profit target, and exiting your trade. While that is an effective way to trade, you may be able to make more profits by trading around a core position if both your technical and fundamental analysis supports a big move in the market over the longer term. But what does trade around a core position mean?
Trading around a core position is a trading strategy whereby a trader has a relatively longer-term position in a security but then makes some short-term trades as the market moves without tampering with the initial long-term position. This method allows the trader to make some profits from the short-term adverse price moves while still keeping the main position. It is mostly used in stock trading but can be applied in other markets, such as futures, ETFs, and cryptocurrency.
In this post, we take a look at a core position and the trade around a core position strategy. We end the article with a backtest.
What does trade around a core position strategy mean?
Trading around a core position is a trading strategy whereby a trader has a relatively longer-term position in a security but then makes some short-term trades as the market moves without tampering with the initial long-term position.
This method allows the trader to make some profits from the short-term adverse price moves while still keeping the main position. It is mostly used in stock trading but can be applied in other markets, such as futures and cryptocurrency.
The strategy takes advantage of the fact that the market does not move in a straight line but rather swings up and down despite its long-term direction.
On the basis of that, a skillful trader can have a long-term position and still try to profit from short-term price swings. It could be viewed as a sort of diversification across time frames because if the core position is a swing trade on the daily timeframe, the “trade around” could be on intraday timeframes — scalping and day trading.
For example, you can trade the same stock in various timeframes. Let’s say you place a swing trade (long) on the daily timeframe which moves significantly in your favor but is still far from your profit target. Then, on the second day, the price pullback significantly but created a buy signal on the hourly timeframe.
You can make an intraday trading on the hourly timeframe and take profit for it at the right level for that hourly timeframe while still maintaining the earlier swing position. Of course, this can lead you to hold a much larger position in a single stock at times. But it might be a good way to make more concentrated bets and still have some level of diversification. However, it could increase risks if not well planned.
To trade around a core position effectively, you need to plan it well. You must know what your maximum position should be, what the initial position (which is the core position) should be, the pullback level to enter another position, and what the position size of the short-term plays should be. We believe algo traders are best equipped for such a strategy.
For example, if you are trading shares, you may want your maximum position size at any point in time to be 3000 shares and your initial core position to be 1500 shares. Then when you see an opportunity for a quick trade on the intraday timeframe, you play it with a 1500 shares position.
You already have a strategy for the intraday play, so when you see a trade signal for the short-term play, you know how much position size to play with to maintain your maximum size rule. By having a maximum position size, you sort of cap your risk. So, you already know what you can lose if things go south. This way, you keep your risk management tight.
What does trade around mean?
Trade around means making a different play that does not affect your main play. In the case of stock trading, it means making other trades in the same stock while still keeping your longer-term position.
You could be bullish on a stock of the long term and have a long position. But then, you can make short-term short or long plays around the position. These short-term plays neither affect your main position nor your long-term sentiments on the stock. You are simply trying to profit from the swinging nature of the price over the short term.
A good example of trading around is making swing plays via a price channel on the H4 timeframe while having a main position.
A trader can hold a long position and still swing trade the price channel — going long when the price hits the lower channel and taking profit at the upper channel. He could also take short positions at the upper channel and cover at the lower channel with a profit.
By so doing, he is trading around the main position as the price swings about while maintaining a long-term trend to the upside.
What does core position mean? What is a core position?
A core position refers to the main position a trader has in an asset. It is the trader’s initial position taken after the assessment of an asset based on fundamental and technical analysis.
It portrays the trader’s long-term bias in an asset. So, if a trader anticipates that a market would be bullish for some time into the future, he can take a long position in the market. Likewise, if he is bearish on the market, he can take a short position.
This relatively longer-term position does not affect the trader’s ability to make short-term plays to take advantage of minor price swings on lower timeframes.
With the right strategies and plan, a trader can trade in different timeframes — have a core position on the higher timeframe, and make short-term plays on the lower timeframes. The profits or losses from the short-term plays do not affect how the trader manages the core position and neither does it affect the position risk management parameters.
The method of having a core position while still taking other trades from signals in lower timeframes in the same asset sort of offers diversification based on timeframes. The profits from short-term trades not only lessen the risk exposure of the core position but also increase profitability.
What does it mean to trade around a core?
To trade around a core means to make other plays in an asset apart from your core position in the asset. It is a trading strategy used by experienced stock traders who have long-term positions on a stock but still want to profit from the short-term price swings in the stock. Here is how the strategy works:
A trader finds a stock that has the potential to rise significantly over the long term, say months, based on some technical analysis and fundamental factors. He can quickly take a long position in the stock to hold it till the anticipated move plays out. As the trade develops, the trader can use other strategies that work on the lower timeframe to find trading opportunities for quick profits. Those can be scalping or day trading strategies.
With a day trading strategy, the trader can find trade setups on the intraday timeframes to go long or short the stock. These trades can end up in profits or losses, but their outcomes do not affect the main position, which was based on an entirely different market assessment and parameters. Profit-taking or exit from the core position is based on the assessment of the overall market bias and not on the intraday price gyrations.
So, if the trader sees a buy setup using an intraday trading strategy, he can take the trade and close that trade based on the intraday trading strategy.
In the same way, if he sees a sell setup, he takes the trade even though it is against the direction of the core position — the intraday bearish assessment doesn’t affect the overall bullish bias in the stock. When the short-sell trade reaches its profit target, he takes it out and pockets the quick profit, and looks for another intraday trade setup the next day, all the while still keeping the core position.
Examples
Let’s say you were bullish on Tesla, Inc. (Nasdaq: TSLA) in August 2021 and your assessment showed that the bullish sentiment might last for up to 3 months. You could buy some 100 shares at $222 per share and plan to hold the position for some 2-3 months. See the chart below:
As the market moved and your trade developed, you saw some interesting intraday price swings you could trade. With a day trading strategy, you could find a way to take those intraday trades and make small profits.
The number of short plays you make would depend on the intraday strategy you use and the timeframe you trade. But for each trade, you may decide to trade 50 shares or 100 shares, whatever you plan to be your maximum trade size. See the H1 timeframe of the same period:
From the chart, you can see that there were a few short-term plays you could have made if you were using stochastic overbought and oversold signals. See the white short arrows. Some of those trades would have made profits, while others would have failed. Whatever their outcomes, your initial position of 100 shares would remain until it reached the time you wanted to take it out.
The point is that your short-term or intraday trades would not affect the core position. You simply trade around it pending when the overall market condition changed.
So, when you make a short play on the hourly timeframe, it does not mean that your bullish bias in the market has changed. It means that the intraday swing for that day was likely to be bearish, and wanted to profit from that. Similarly, you make a long play on the hourly timeframe, you do not play to hold it along with the core long position; rather you aim to cash in some quick profits. Thus, it is not a scale-in situation.
The exit for the core position would eventually come when you think the bullish bias in the market has changed based on your market analysis. See the chart below:
Where does it come from?
The trade around a core position strategy came from smart traders who were looking for a way to merge the power of active trading with long-term buy-and-hold.
In the process, they found out that it can be played with any combination of trading styles. You can have a core swing position and scalp around it or even day-trade around it.
Similarly, you can have a core long-term position or buy-and-hold position and swing-trade around it. Essentially, the strategy is based on the logic of diversification, but in this case, across timeframes and possibly trading strategies.
What are the rules of the strategy?
Every trader has his own rules based on what works and does not work for him. However, there are a few tips to keep in mind:
- Know your risk tolerance: It is essential you know your risk tolerance beforehand and plan your trades accordingly. Don’t take more than you can handle and be ready to follow your plan at all times. That way, you do not trade emotionally.
- Have a maximum position size: As a way of keeping to your risk level, you must have a maximum position size you must not exceed at any point in time. That is, both your core position and the short-term play must not exceed that.
- Have a different strategy for the core position and the short-term plays: You may use the same strategy for both and only utilize timeframe diversification, but you can manage risk better by having a strategy diversification as well.
- Know the stock to trade: You should use the strategy only on stocks that have good liquidity and volatility. You need liquidity to be able to enter and exit positions at will, and at the same time, you need volatility to see sizeable short-term price swings to play.
Trading around a core position strategy backtest
Let’s go from theory to practice and backtest how to trade around a core position. We make the following assumptions:
- You start by allocating 50% of your capital to a buy-and-hold position in S&P 500 (SPY).
- The remaining 50% is allocated for buying low and selling high in S&P 500. You use a specific trading strategy – a mean reversion trading strategy.
- You are invested in short-term Treasury bonds (SHY) when not trading around a core position.
In summary, you have a long-term core position in SPY but rotate between stocks (SPY) and short-term bonds (SHY) with the remaining capital.
We prefer SHY because it has a short duration (1-3 years) and thus has less risk and interest sensitivity than longer maturities. If we used longer maturity, for example, TLT (20 years), the annual returns are better (see more below).
The trading strategy that we use to trade around the core position is trading strategy #2. Because it’s a strategy that we sell behind a paywall, we don’t want to its trading rules.
How has the trade around a core position strategy performed?
The chart below shows both the equity curves of buy and hold (of SPY) and the “trade around a core position” strategy:
As you can see, the blue line, which is trade around a core position, performed significantly better:
| Buy and hold | Trade around a core position | |
| CAGR/Annual return | 9.9% | 11.3% |
| Max drawdown | 55% | 25% |
| CAR/MaxDD | 0.18 | 0.46 |
| RAR/MaxDD | 0.18 | 0.51 |
| Ulcer Index | 12.5 | 3.8 |
(If you are unsure of some of the components in the table, please read our article about how to measure trading performance.)
As indicated in the chart, our trade around a core position strategy cannot keep up with buy and hold when you have a strong bull market, as we witnessed from 2010 until today. Opposite, in a bear market, our strategy has outperformed buy and hold massively and can thus start compounding from a higher base (after the bear market).
Let’s make a second backtest where we swap SHY with TLT. As mentioned, TLT has a longer duration and more risk (more volatility), but you should get rewarded for taking that risk in the long term.
We use the same trading rules:
- You start by allocating 50% of your capital to a buy-and-hold position in S&P 500 (SPY).
- The remaining 50% is allocated for buying low and selling high in S&P 500. You use a specific trading strategy – a mean reversion trading strategy.
- You are invested in short-term Treasury bonds (TLT) when not trading around a core position
The equity curve looks like this:
As you can see, the blue line, which is trade around a core position, performed significantly better when we used TLT instead of SHY (as expected):
| Buy and hold | Trade around a core position | |
| CAGR/Annual return | 9.9% | 13.5% |
| Max drawdown | 55% | 20% |
| CAR/MaxDD | 0.18 | 0.66 |
| RAR/MaxDD | 0.18 | 0.81 |
| Ulcer Index | 12.5 | 3.8 |
When stocks have performed poorly, TLT witnessed a flight to safe havens, thus it has performed better than SHY. However, that didn’t happen in 2022 when bonds crashed. So this is not foolproof – far from it.
Admittedly, taxes and commissions are not included. Such a strategy has to be done in a tax-deferred account, and commissions and slippage are low. Please read how much impact commissions play in our account (hint: not much):
Trade around a core position strategy – conclusion
Trade around a core position can be profitable if you have a clear-cut trading plan.
Some might not want to take the risk of allocating 100% of the capital to short-term trading, and thus trading around a core position might be helpful. Also, as shown in the backtests, it might be done to increase returns and lower risk.
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