Knowing these four things about every trade you take will not only help you avoid making foolish mistakes, but can also help you read the market better. These concepts are derived (but added to) from The Complete Turtle Trader, a book that is entertaining, has some great lessons, and is worth the read.
1. What is the Market Doing?
No matter if you trade currency pairs, commodities, stocks or options you need to know what the market you are trading is doing. This seems obvious, but many traders make the mistake of assuming what the market will do, instead of looking at what it is actually doing.
Is there is a trend or is there a range? Is the price consolidating within a trend, or trading near a range extreme?
Is the uptrend making overall higher highs and higher lows, or is the trend in question? Is the downtrend making lower lows and lower highs?
Any chart patterns you can see that may provide some estimate of where the price could run to?
These types of questions will help you assess the probabilities of your trades, and understand what the market is actually doing.
2. How is the Market Moving?
Think of this question in terms of volatility. Is the market moving quickly and sharply, or is it meandering slowly?
This is important because it lets you know how long you can expect to be in trades. Quick and sharp movements typically mean short trade time frames, since a profit can be collected as soon as one of those fast moves occurs.
If the market is moving very slowly, volume is low and there is very little interest in the market, the price moves much slower. This needs to be accounted for. Jumping in and out the market, when it is very slow, will likely only result in a bunch of losing trades. Instead, allow time for the market to move, making the trade worthwhile. And if there isn’t enough movement to even warrant a trade, then stay out.
Focus on trading on during times when conditions favor you. The rest of the time, sit on your hands.
3. What’s Your Strategy?
Never get into a trade without a defined strategy for why and how you will manage that trade.
Before every trade know why you are getting in, and why this entry point is ideal. Typically this will be because you have a tested out a strategy and that tested strategy dictates that this entry point will help you make money over a great many trades.
If trading traditional markets you’ll also need to know in advance of taking the trade what your exit plan is, for both losses and profits.
4. What’s Your Risk?
Know how much you are going to risk on each trade. Typically it is recommended that you wager a small percentage of your account on each trade, for example, 1 or 2 percent.
This way you never have to arbitrarily decide how to much to risk, you always know. A major problem is that some traders risk a bunch on one trade, and a little on another, then a different amount on another. Using this approach, it is very hard to determine how your strategy is working. If risk $500 one on trade and lose it, but win on 8 others you only risk $40 on, your results won’t reflect that you may have a winning system. Had you risked $40 on all trades, you’d be up substantially, but because there was a massively disproportionate loser in there, your results are skewed.
Define your risk, and stick to it.
Know what you are trading! Know what the market is doing and how it is moving. Use this to assess whether you should be trading. You should be employing a well tested strategy, which means you know when that strategy should be traded and when it shouldn’t. Before every trade know what your strategy for entering and exiting is. The strategy should accommodate for current market conditions. Also know your risk on each trade. Preferably risk a fixed small percentage of your account on each trade–we don’t know which trades are going to be winners and which are going to be losers so risk similar amounts on all of them.