By Gabe Velazquez, Online Trading Academy E-minis Instructor
In the development of a trader, there are certain steps that have to be followed, practiced, and finally mastered, in order to become successful. In this missive, I'm going to delineate these areas, addressing them in the sequence that a new trader should focus on.
The four distinct facets of the trading process are as follows:
- Identify
- Assess
- Execute
- Manage
This framework can help a trader spot specific areas that he/she is strong or weak in.
First, I'm going to assume that most of you reading this newsletter have had some exposure to technical analysis. That's a good starting point; however, how many of you can identify a set of conditions that will prompt you to enter a long or a short trade? In other words, can you spot on a price graph, specifically, the why, where, and when to trigger a low-risk trade?
This is step one, the identification stage. It makes sense that a neophyte would have to learn to train his eyes to recognize high probability buy and sell zones in order to build an Action Plan for trading, that is if he/she has any chance of succeeding against the professional trader that's out to take his/her money. In the beginning, this is where most of the time will be spent. I tell my students that they cannot progress to the next step (the assessment stage) until they become proficient at finding those good, low risk entries on a price chart. Moreover, this is the stage where they will find out what works, and what doesn't work for them, in particular. Finding one's wheelhouse (style of trading) is also done in this step.
Once a setup has been identified, the next step is to assess the risk versus reward potential of that trade. At Online Trading Academy, we teach a one-to-three risk/reward ratio as the minimum required to deem a trade actionable. In addition, determining the dollar amount that one is comfortable with is part of this facet. This can be done by calibrating the contract or share size appropriately. One method of determining the profit potential of a trade is simply to enter at a support (demand area) and look for the next closest resistance (supply). If the difference is greater than three times the amount that's at risk, then the trade is worth doing.
So far, we've identified the set of conditions that we would like to see to set up a trade. We've then assessed that entry for risk against potential profitability. Everything checks out, now it's time to pull the trigger (execute). This and the latter (management of the trade stage) are by far the two most important aspects of the trade. Essentially, they are the difference between being consistently profitable and just making good trading calls. Just as is the case with any endeavor, execution (follow-through) is everything.
Now that the trade is on, the next and most important job is managing it. This is the stage where an exit strategy consisting of clear rules to maximize profits must be implemented. Whether we use a trailing stop, a technical signal, or a combination of both to exit, is irrelevant. The bottom line is one must have the same specificity in exiting a trade as in the entry.
For many traders the last two parts of this progression are usually the most challenging. Why is this? During the analysis stage of the trade process, we can be perfectly analytical because up to that point, there isn't anything at stake. However, that changes quickly as we enter the market. I joke to my students that in the two initial phases, our I.Q's are between 100 and 120 and as soon as we enter the market, they immediately drop 40 points. That's because, suddenly, everything's at stake: Our money, and our ego. This simply translates into emotion, that is, if you don't have an exit strategy.
All told, the parallels between trading and performance sports are strikingly similar. In golfing, as an example, if you have a good long game (identifying and assessing), but are lacking in your short game (executing) and particularly putting (managing), you'll have a tough time being a competitive golfer (consistently profitable trader). I hope that by breaking down trading into a four-step process, it will help you gain a better understanding of what needs to be worked on to increase your trading performance.
Until next time, I hope everyone has a profitable week.
If you have questions or comments, please email me at gvelazquez@tradingacademy.com
- Gabe Velazquez
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