Here’s the scenario … you’ve got a set-up … or a tip … and you’re about to place a trade.
Your mouse is hovering over the ‘buy’ or ‘sell’ button … that little voice in your head is questioning whether it’s really a good idea …
What should you do?
Here’s a simple way to test if your trade is a good idea, or not. Do you know the answer to these 6 questions?
What are the criteria I’m following to enter this trade?
I’m going to take for granted here that you’re following a strategy with systematic trading rules.
So, the question is – are you following those rules?
Are you’re ‘adapting’ your rules to fit with what the market is doing?
This isn’t necessarily a crime (market conditions, like most things in life, rarely match the text books), but if it’s not already part of your strategy, it needs to be worked into it, so you consistently deal with situations. And if you’re making changes – they need to be tested out before you risk your money on it.
If you don’t have a trading plan, and are struggling to know where to start, take a look at these three simple plans: Click here.
What are my plans for exiting this trade, both as a winner or a loss?
Too often, our plans focus on what we’ll do when things go according to plan. But what will you do if they don’t?
Yes, have your clear take profit level, but what will you do if the price is hovering around your stop level? Will you cut and run, or wait for the trade to come good.
Will you use trailing stops? Or take partial profits?
Do you have a timescale after which you’ll close the trade, whether it’s in profit or not? Remember, the longer your trade is open, the longer your money is at risk in the markets.
What is my risk?
It’s so fundamental that we should NEVER enter a trade without a clear idea of what the risks are.
Day traders shouldn’t risk more than 1 or 2% of their trading fund (this will vary, depending on the risk profile of the strategy) … and your total risk for a spread bet is calculated as your distance to stop multiplied by your stake.
Yet, again and again I see trading accounts and records showing arbitrary stakes of £1 or £5 … irrespective of the stop distance.
There’s no excuse for straying from these rules … If you’re not doing it already, please download my stake calculator so you can include this in your routine before you place ANY trade.
What is the overall trend?
If we trade in the direction of the trend, it’s going to be easier to make money. If we trade in the opposite direction, making a profit is like trying to walk backwards up an escalator – yes, it’s possible, but it’ll take you longer to get there, requires more effort, and makes you look a bit daft.
But the problem is that when we’re day trading, it’s easy to lose sight of the over-arching trend in the market – we get so bogged down in the small ups and downs of the day.
The chart below shows 5minute candles over a 3 day period, where the market is clearly in a downtrend. While day trading, it would be easy to miss this unless you pull out to look at the bigger picture.
Are there any key levels blocking my success?
We’ve all done it (well, I know I have) – mechanically setting my stop loss and profit target according to the rules of my strategy … only to realise too late that to win, the price would have had to move through a significant key level. Or that the stops loss is on a round number, where the price is likely to be driven like a magnet.
On the chart below, we get a signal to sell into this downtrend …
However, when we look at the same moment on a daily chart, we see that we’re selling just as the price hits a significant support level …
The way to avoid making this mistake is – again – to pull back and look at the bigger picture. It’s useful to draw a few key levels on your chart, so they’re still there to remind you, when you’re head-down day trading on a smaller timeframe.
Are there any major news items coming up?
You don’t need a degree in economics to trade the financial markets – you just need to know when a piece of impending news could derail your trade.
While we can’t predict what bankers will announce, or what effect that will have on the market (it’s often the opposite of what we might expect), we can make ourselves aware of scheduled announcements.
Forexfactory.com lists all the economic announcements happening each week, and the markets they are likely to effect. The main events to watch out for are Non-Farm Payrolls on the first Friday of every month.
If you’re concerned about an upcoming announcement of news event, it’s notoriously difficult to predict how markets will react, plus the added volatility can make a mockery of our usual stop levels. My advice is to sit out of any event you’re concerned about – there will always be other opportunities to trade (as long as you keep your fund nice and safe).
Got the green light?
So, if you can satisfactorily answer the six questions above, then you can be confident that you’re trading your plan.
Even the best-planned, meticulously executed trades can be losers.
But I can guarantee that if you’re unable to answer these questions, you’ll not have any chance of long-term success in the markets. Yes, you might get lucky for a while … but to generate real wealth, you need to be methodical. It’s not a long check list … just six key facts to know.
I recommend scribbling them down on a post-it note to remind yourself each time you’re about to hit that button …