Hello traders! At the time of this writing, I am enjoying the unusually warm temperatures in sunny southern California, 85 degrees to be exact! Tearing myself away from the beach in the middle of the winter to write this newsletter has been difficult, but I will try to make it worthwhile. This week I’d like to explain the three parts that every trade has, and the respective importance of each part.
The title of this article includes the acronym that we teach in class “S.E.T.” This actually means STOP-ENTRY-TARGET. Every trade I take, every trade that you take, and every trade that we instructors talk about should have all three parts of the trade PLANNED OUT AHEAD OF TIME.
Too many times new traders see a particular movement on the charts and rush into a position, giving little or no thought to how they will exit a particular trade. “It’s going up now, I have to get in!” is a common thought when considering an entry (the “E” in S.E.T.). By getting in now with no plan on the exits of the trade, how will you know when to cut your losses or take your profits? Very often when you must get in now, most if not all of the move has already happened. The turn in price (where we are looking to enter) has likely happened several candles ago, and now you would be chasing this trade. Many traders consider the entry to be the most important part of the trade; with a good entry you get a smaller stop loss, and a larger profit target. I could not disagree with the traders who have this opinion!
If you are entering well after the turn in price, where does your stop loss go? Your stop loss is the “S” in S.E.T. In the Online Trading Academy classes that we teach, your stop loss goes on the other side of the zone you used for your entry. Put another way, on the other side of the distal line of your zone which requires two lines to define. Some people consider the stop loss as the most important part of any trade, and I can’t argue with that opinion either. Without a properly placed stop loss, this one trade could cause major damage to your account. What about not using a stop loss? Because of the power of this leveraged asset class, one trade that goes against you too far can effectively wipe out your entire account!
If you enter a trade too far from the turn in price, your risk (where your stop goes) may be equal to or even more than the target! The “T” in S.E.T. is your profit target. In our classes we recommend that your target is at least three times what your risk is, a 3:1 reward to risk ratio. The further you enter from the turn in price, the smaller your profit target becomes. Earlier in this article I mentioned that some traders believe the entry is the most important part of the trade, and others believe the stop loss the most important. I’ve been racking my brain trying to remember an experienced trader who believes the profit target is the most important part of the trade. With over 17 years of trading experience and 8 years of teaching meeting hundreds if not thousands of traders, I can’t think of one! This is the opposite of most new traders! In many of my classes, new students will often say that this is the most important part of the trade. I definitely disagree with this opinion. Most experienced traders will have heard or even live the phrase, “Take care of your losses, the winners will take care of themselves.”
While we believe this to be true, the question is often asked in class “should I put a target order in the system?” What this means is the trader will exit the trade when the trading price reaches their predetermined profit target figure. Because the spot forex market trades consistently from Sunday afternoon to Friday afternoon, open 24 hours a day, I recommend to traders to put their profit target into the system. Unless you are one of those rare people who plan on staying awake staring at the screen for several days at a time. The main reason is obvious – price might hit your target when you aren’t expecting it. Other reasons to place your exit orders in the system include a power outage, a system crash, and whatever other distractions might prevent you from placing a trade.
In the future, I hope I don’t get any emails from readers of this newsletter stating that they took a long trade after a large move up in price, with a 100 pip stop loss and a 10 pip profit target! Know the S.E.T. process, where we enter our trades in high quality supply or demand zones, place our stop loss a few pips on the other side of the zone, and place our profit target a few pips before the next zone with at least a three to one reward to risk ratio.
Until next time,