No matter which market you trade-stocks, foreign exchange or futures-every second the market opens offers trading opportunities.But not every second can provide High probability trading. In a sea of almost infinite possibilities, perform a five-step test for each transaction you consider so that you will only conduct transactions that conform to your trading plan and provide good profit potential for the risks you assume. Whether you are a day trader, swing trader or investor, you can apply the test.
It takes some practice at first, but once you are familiar with the process, it only takes a few seconds to see whether a transaction has passed the test and tell you whether you should trade.
- Regardless of your trading strategy, success depends on discipline, knowledge and thoroughness.
- Here, we will introduce five simple steps to be performed before making any transaction.
- These include understanding your strategies and plans, identifying opportunities to understand your entry and exit goals, and knowing when to abandon bad trades.
Only trade if you pass this 5-step test
Step 1: Transaction settings
Setting is even considering the basic condition that the transaction needs to exist. For example, if you are a trend-following trader, you need to have a trend. Your trading plan should define what is a tradable trend (for your strategy). This will help you avoid trading when the trend does not exist. Think of “settings” as your reason for trading.
Figure 1 shows an example of this operation. The overall stock price rose, manifested by higher highs and lows swings, and prices above the 200-day moving average. Your trading settings may vary, but you should make sure that the conditions are conducive to the strategy you are trading.
Figure 1. Stocks in an uptrend, providing possible trading settings for trend traders
If your trading reason does not exist, please do not trade. If your transaction reason-set-Yes Exist, then proceed to the next step.
Step 2: Transaction trigger
If your trading reason exists, you still need a precise event to tell you now It’s time to trade. In Figure 1, the stock is in an uptrend throughout the time, but certain moments in the uptrend provide better trading opportunities than others.
Some traders like to buy at new highs when prices fluctuate or fall back. In this case, when the price rebounded above the $122 resistance level in August, trading may be triggered.
Other traders like to buy during the pullback. In this case, when the price falls back to the support level near $115, wait for the price to form a bullish engulfing pattern or consolidate several price bars, and then break the consolidation. Both of these are precise events that distinguish trading opportunities from all other price movements (you have no strategy).
Figure 2. Possible trading triggers in rising stocks
Figure 2 shows three possible trade triggers that occurred during this stock’s upward trend.what yours The exact transaction trigger depends on the trading strategy you use. The first is the consolidation near the support: a trade is triggered when the price is higher than the consolidation high. Another possible trade trigger is a bullish engulfing pattern near the support: a bullish position is triggered when a bullish candle is formed. The third trigger point for buying is a rebound to a new high after a pullback or range pullback.
Before making a transaction, please check to make sure that the transaction is worth Taking. Using trading triggers, you can always know in advance where your entry point is. For example, throughout July, traders know that the possible trigger point for trading is a rebound above the June high. This provides time to check the validity of the transaction before the actual transaction, steps three to five.
Step 3: Stop loss
Having the right entry conditions and understanding your transaction trigger points is not enough to generate a good transaction. The risk of this transaction must also be managed through a stop loss order. There are many ways to set a stop loss. For long trades, the stop loss is usually set slightly below the low point of recent volatility, while for short trades, the stop loss is usually set slightly above the high point of recent volatility.
Another method is called average true range (ATR) stop loss; it involves placing a stop loss order at a certain distance from the entry price based on volatility.
Figure 3. Example of long trade with stop loss
Determine your stop loss position. Once you know the entry and stop loss prices, you can calculate the size of the trade’s position.
Step 4: Price target
You now know the conditions that are conducive to trading, as well as the positions of entry points and stop losses. Next, consider the profit potential.
The profit target is based on something measurable, not just randomly selected. For example, the chart mode provides targets based on the size of the mode. The trend channel shows that the price has a reversal trend; if you buy near the bottom of the channel, set a price target near the top of the channel.
In Figure 3, the widest point of the euro/dollar triangle pattern is about 600 points. Add to the triangle breakout price and provide a target of 1.1650. If the trading triangle breaks the strategy, that is where the target (profit) is to exit the transaction.
Determine your profit target based on the market trends you trade. Trailing stops can also be used to exit profitable trades. If you use trailing stop loss, you will not be able to know your profit potential in advance. But this is good because trailing stop loss allows you to extract profits from the market in a systematic (rather than random) way.
Step 5: Risk reward
Try to trade only when the potential profit is greater than 1.5 times the risk. For example, if the price reaches your stop loss, a loss of $100 means that if the target price is reached, you should make $150 or more.
In Figure 3, the risk is 210 points (the difference between the entry price and the stop loss), but the profit potential is 600 points. This is a risk-reward ratio of 2.86:1 (or 600/210).
If you use trailing stop loss, you will not be able to calculate the risk return of the transaction. However, when trading, you should still consider whether the profit potential may exceed the risk.
If the profit potential is close to or lower than the risk, avoid trading. This may mean doing all this work just to realize that you shouldn’t be trading. Avoiding bad transactions is as important to success as participating in favorable transactions.
Other matters needing attention
The five-step test acts as a filter, so you only make trades that are consistent with your strategy, ensuring that these trades provide good profit potential relative to risk. Add other steps to suit your trading style. For example, day traders may wish to avoid opening positions before major economic data or company earnings are released. In this case, to make a transaction, check the economic calendar and make sure that no such event is scheduled when you may be involved in the transaction.
Make sure that the conditions are suitable for a particular strategy for trading.Set up a trigger that tells you now It’s time to take action. Set stop losses and targets, and then determine whether the return is greater than the risk. If it is, proceed with the transaction; if not, please look for a better opportunity. Consider other factors that may affect your transaction and implement other steps when needed.
This may seem like a tedious process, but once you understand your strategy and get used to these steps, you should be able to browse the entire list in just a few seconds. It pays to ensure that every transaction passes the five-step test.