The Anatomy of a Trading Decision
If your desire is to become a consistently profitable trader, trades can’t be made on random impulse, guesses or hunches.
Trading is methodical and calculated; part of a process which is repeated again and again. Not a single trade takes place outside this of this process. Below is my process for taking swing trades, which the majority of my trades have been lately. In the Considerations section I related how this process is easily adapted to day trading by altering the time frames that are monitored.
1. Trade Direction-Trend
Pick out the trend. For swing trades I use a 4-hour chart. Whenever possible I draw trend channels to help visualize the trend, where there price has room to run, and where support and resistance area (diagonal). Trend channel connect significant price highs to other significant price highs, and significant price lows to other significant price lows.
If the channel is down, I am only looking for short (put) trades, and only near the top of the channel. That way there is room for the price to fall away from resistance and toward support. Selling near the low or middle of the channel is a lower probability trade, since the price can more easily gyrate back and forth (causing a loss) since the trade doesn’t occur at the probable (when combined with the steps below) backstop of the trend channel.
2. Short-Term Shift
Continuing with the example, if the 4-hour trend channel is down, and the price is near the top of the channel I am looking for a short (put) trade. I don’t just randomly take a trade near the top of the channel though. I need confirmation that the price is stopping near the top of the channel and is reversing back lower.
To get this confirmation I drop down to an hourly chart. From this chart I need to see some evidence of bearishness near the far right of the chart. This evidence may be a lower high, a lower low or a failed breakout higher above a former high.
3. Find the Entry Setup
If the above evidence is present I drop down to a 15-minute chart. To trigger an entry I must see a lower low on the 15-minute chart (trend is down) near the far right of the chart. When this occurs I put out an order to go short on a pullback higher. In prior articles numerous entry signals are provided, including the Valley Floor and Mini-Channel Breakouts.
At this point implement other tools to improve the odds of your entry. Such tools include Fibonacci Retracements.
4. Establish Trade Management Parameters
The entry is located, or the conditions for entry are now known. Then, determine your position size. Your risk on the trade shouldn’t exceed 2% of your trading account, 1% is better.
If trading European binary options, once you place the trade you don’t have much to do. If trading traditional markets you must choice a stop level so your risk is controlled; this allows you to calculate your position size. Set a profit target or establish how you will exit a profitable trade; trailing stops, or exiting a portion of the position at different targets, are ways to exit.
Based on the outlook for the trade, and the risk and profit potential based on your realistic targets, assess whether the trade is worth taking. If it is, take the trade. If it isn’t, skip the trade and look for other opportunities.
Considerations and Final Word
While your process may vary, your process must occur before every trade. No trade happens without the process occurring. If you take a trade where you didn’t go through this process, exit immediately (if possible) even if it means taking a small loss. Without a methodical process you are gambling; gambling may payoff occasionally, but will eventually leave you with an empty account.
Parts of this process are subjective. Precisely define all parameters in your trading plan if you are a new trader; experienced traders with proven discipline often retain some subjectively in their trading.
When day trading, use an hourly or 30-minute chart for your overall trend analysis (direction). Use a 5-minute or 1-minute chart to establish entries and stops. Use filters if applicable, and establish the parameters of the trade using the same method as indicated above. Even though day trades can be very quick, a methodical process is still used. Experience and practice allows you to go through the trade selection process in a matter of seconds, so you won’t miss trades. There is no reason to not go through this process (or one similar) for every single trade you make.