How To Correctly Plan And Execute a Trade
You lose or win before you enter the trade
That might sound intriguing but it’s very accurate. Imagine the following scenario: you decide to buy asset X, execute the trade, price goes lower and it doesn’t seem to stop. You freeze, don’t know what do and losses keep growing. Is the trade still valid, should you get out or wait and hope for a reversal? Those are the questions that your mind’s busy trying to figure out an answer to.
Now let’s look at the second scenario: you decide to buy asset X, determine that entering at price level Y with a 5 points stop will provide you a 2:1 risk-reward. If price moves below your stop you agree that your trade idea is invalid and it’s not worth staying in. Note that price is not yet at level Y where we want it to be so we will sit tight and just wait.
Spot the difference? It’s huge. In the first scenario we executed the trade without any plan like a lot of the retail traders that try their luck in the markets, while in the second scenario we had a plan and knew exactly what we will do if that particular scenario showed up. We wait and react when the stars align.
Key aspects to consider prior to execution
Even though in the second scenario we had a plan and it sounded much better than not having one we can do better. Next I will go through a list of things that you should check before pulling the trigger. Let’s call it the trade checklist.
1. Trade location
It’s critical that you enter a trade at a support or resistance level. Jumping in in the middle of nowhere is a recipe for disaster. So know the level that makes the most sense for you and where you expect a reaction from the market and just sit tight if price is not there yet.
2. Larger time frame trend
“Trend is your friend”, you’ve probably already heard this phrase and that’s great because you need to keep this in mind: your chances of success increase if you are joining a larger time frame trend and obviously they aren’t so good if you try to fade it. So always try to asses who is in control, buyers or sellers and join them, don’t go against them.
There is no standard rule here but as a general recommendation you should look for trades with a 2:1 risk to reward ratio. Simply put you are willing to risk $100 to make $200. If you don’t see anything that fits this criteria just wait, patience is key. Opportunities will come.
Knowing when to take profits is as important as knowing when to scrape the trade if it goes against you. Prior to entering the trade you should have these levels set so when the price gets there you just execute, emotionless. If you don’t you’ll fall into the spiral of greed and hope. You’ll want more if you’re winning and you’ll hope for a reversal if you’re losing.
Remember, having a plan is essential in pretty much anything we do and it stays true for trading as well. Without it we are an easy pray for the bigger players in the markets that are looking to get our funds.
I suggest you use a paper or a spreadsheet, whatever you feel comfortable with, write those criteria as checkboxes and whenever you see an opportunity just go through your checklist and see how many boxes are checked. That will quickly tell you if it’s worth risking your capital or not. The more boxes you check the higher the probability that your trade will work. Also keep in mind that even if a trade didn’t pass your checklist that doesn’t mean it will fail, it might work and that’s ok. But that doesn’t mean you should have taken it. You’re here for the longer term, you need consistency not a few lucky winners.