Why clear entry and exit prices are vital to traders
Since I took the helm of The Trading Point, some of you have been kind enough to email in with questions and observations, all of which are much appreciated.
One question in particular struck a chord…
It concerned a potential trade idea that wasn’t triggered and the question was whether, on the basis that it wasn’t triggered, the analysis was valid in the first place.
I was more than happy that my analysis was valid. But it set me thinking about my approach and the discipline of having well defined entry and exit criteria for each and every trade you do, or indeed don’t do.
Trading is a discipline. Getting it right all the time can be hard. If it wasn’t it would mean free money for all, wouldn’t it?
The reason I always adopt a disciplined approach to trading, is in an effort to systemise and remove emotion and “shoot from the hip” reactions.
That doesn’t mean completely ruling out intuition or gut feelings, as these can be useful subconscious cues.
But it does mean having a plan – a style or approach to refer to and utilise every time you trade.
Quite simply, trading is about endeavouring to accumulate capital. It’s about taking calculated risks and pitting yourself against everyone else in the markets each time you take a position.
Because, in most circumstances, for you to be a winner someone else has to be a loser.
The risks that you take in trading are to your capital – money that you have probably worked hard for. And what was hard won should not be lightly dismissed or frittered away.
When it comes to the markets, you can never know it all…
Now, after 30 years in the markets I think I know quite a bit about them, but I don’t pretend to know everything and I don’t believe that I or anyone else ever will.
That’s because at some level the markets are the distillations of the hopes, fears and other emotions of millions of individual participants. Be they traders at large institutions or private investors.
You could even argue that algorithmic and computerised trading, which these days can take place without human intervention, still reflects these emotions because they have been programmed by us.
When I think about entering a trade, I consider what I would need to see to convince me that there is scope for genuine move in a given direction and what would persuade me that there is not?
To that end, I like to see price action that creates a trend change or takes out key price points, such as prior period highs or lows.
But reaching and/or breaching these levels is not sufficient justification in itself, as far as I am concerned.
Rather, I want to see sustained moves, supported by good volume and perhaps other confirmatory signals.
If I don’t get those, then I risk jumping in on what may simply be a false move or a non-event.
Because make no mistake, there are people out there who like nothing better than tripping you up and taking your money.
It’s not personal, it’s just business as they say.
The business of trading.
So that’s why I nominate an entry point and often other criteria in a potential trade idea. For example, a weekly close at or above a specific price point.
In effect I want the market to tell me what’s happening and where the balance of supply and demand is, because that’s what drives price action.
An excess of one over the other pushes a price in a particular direction, until the point that this balance changes and the price resets.
Perhaps that change comes about because of some new information, or a swing in sentiment. We may never know, but we must always be alert to the possibility.
Once we are in a trade we need to know what our objectives are…
Now of course, our objective is to make money. But how will we make that money? And how much new money will there be, if we are right? And what are we prepared to risk to get it.
None of this should be decided on the hoof. We should be very clear about our objectives well before pulling the trigger on a trade.
Capital preservation and a sensible approach to risk management are the cornerstones of any successful long-term trading strategy.
And that means having a profit target or targets on each trade and, at the same time, a predefined stop loss.
The difference between these two price points defines the risk reward ratio in a trade.
For our purposes the risk should always be of a lower monetary value than the reward and ideally by a multiple.
For instance I look for a ratio of at least 2:1. That is, I want a profit to be at least twice the amount of capital I am prepared to risk on a trade.
Less than this and you are moving into territory that’s akin to tossing a coin.
Speaking of risk…
Speaking of risk; stop losses help to define this key factor and we must think carefully about their placement.
We want to be stopped out if our idea is demonstrably wrong, but we don’t want them (our stop losses) to be seen as low hanging by the market either.
Now this is important: stop losses can be subject to slippage. That is, they may be triggered at the stop price but executed at the next available price – which could be something very different indeed.
There are limited risk or guaranteed stop accounts out there, but they may lack flexibility in other areas.
As well as having a stop loss in place we need to make sure our trade is the “right size” for our account.
After all, you don’t want a single errant position to take down your whole account. This is particularly relevant to those trading on margin.
So think about what your total underlying risk is in any trade versus your overall account size.
I hope that’s given you some food for thought.
If you have any more questions for me on any of the issues I talk about, drop me an email on firstname.lastname@example.org