A Reason for What You Do

Aug 22, 2007: 7:04 PM CST

It pays to be selective with your trade set-ups and entries. Sub-prime setups often lead to sub-optimal trading results. How can you be sure you’re taking the highest probability trades?

While a discussion on high probability trading is well beyond the scope of any singular blog post, it helps to be able to articulate – at least to yourself – why you took the trades you did. Were you bored? Did you crave action? Should you have waited a bit more before buying a potential test of support?

When considering taking a trade, mentally answer these questions:

  • Why am I about to enter this trade?
    • Is price coming up on a support level?
    • Do buyers seem to be overtaking sellers at this time?
    • Do my indicators indicate favorable probabilities for entry?
    • What is my emotional state – bored, anxious, overwhelmed?

       

  • Why would a seller want to sell their stock (or contract) to you at this price?
    • Do they believe the entire move has exhausted?
    • Are they short and are needing to cover?
    • Are they long and feel there’s more risk in holding the stock than not?

     

  • Is there an impetus for further price movement?
    • If price reaches a certain level, will price continue in my direction?
    • What reason is there for price to behave as you expect?
    • Is there any reason at all that price should NOT move in your expected direction?

     

  • What level (or what event must occur) for me to exit, thus invalidating my trade idea?
    • Is there a clear level (moving average breach, etc) or is it undefined?
    • How close is that point to my entry (aka: “Am I chasing price?”)
    • Does the relation to the exit point favor well when compared to my price target?

While it’s not necessary to evaluate each question or scenario when taking trades, it helps to have some structure or ‘checklist’ that keeps you honest in your intentions.

It may be helpful to ask the following questions to yourself as well:

  • Am I ‘revenge-trading’ after a large loss or series of losses?
  • Am I overconfident after a large win or series of wins (aka: “Is my position size too large because I don’t think I can fail?”)
  • Am I not feeling 100% for whatever reason, and if so, should I reduce trading size (or frequency) because of it?

Quick Checklist

A quick and simple physical (written) checklist – based on what works for you – may be all it takes to enable you to take higher quality trade setups that lead to better than average results.

Go down the list and give a quick thought to the following broad categories:

  1. Overall Market
  2. Recent Price Action of Stock/Contract
  3. Quality of Set-up (and your ability to recognize it)
  4. Personal Emotional/Physical State
  5. Sufficient Reason Behind the Trade

Addressing these issues, and ensuring that as many reasons line up as possible before entry, will help eliminate some of the “forced errors” that can occur when we trade under conditions that don’t permit us to be our best.

After all, how much more profitable would you be if you eliminated your five largest losers of the year that could have been avoided if you had followed your rules or identified a clear reason for the actions you took at the time you took them?

Focus on eliminating simple mistakes and odds are your trading will be more profitable because of it.

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