Lessons from the Pros


Trading Basics: Define Your Trading Process

Speculating in the financial markets can be extremely challenging; this is due to all the unknown factors that are continuously present in the markets.  The nature of markets is that nothing is certain and everything can change quickly. For us mere mortals, the concepts of risk and uncertainty can be extremely hard to deal with as most of us are not hardwired to accept these as a part of  daily life. As traders, however, these factors are indeed the reality of everyday life and as such a tested trading process is of critical importance.

In this week’s article, I’m going to go through three basic steps that should help traders formulate a trading process.  Obviously, going through the particulars of a strategy is beyond the scope of this article; nonetheless, putting a trading process together can possibly help get a struggling trader on the right path. So, let’s get started.

The first step in a well-defined trading process is to identify where to enter a market with the lowest risk, highest probability, highest potential for your desired outcome. To do this, we must look at a price chart looking for both supply (where the unfilled sell orders are likely to be found) and demand levels (where the unfilled buy orders are positioned). This has to be done in various timeframes as we don’t know in what timeframe that formation will reveal itself.  The purpose in finding these areas of supply and demand is so that we can anticipate when the market we’re trading touches either one of these levels and will reverse direction. At supply, we expect the market to turn down, and conversely, at demand it should rally. These are considered the lowest risk entry points.

In the chart below, we see a supply zone in the WTI crude oil contract that was created on February 25.  We expect (no guarantees) that the CLJ19 will turn down when this zone is reached. This would be our shorting zone. How far it might fall is a function of where the opposing level is determined.  This constitutes our potential target.

Stock chart for crude oil trade example.

The first step allows us to quantify risk and reward.  In this example, the entry at the supply zone, the stop (above the supply) and the target slightly above the opposing demand zone (the blue line). A key point is that the distance between both levels should be far enough away so that even if we’re right only a small percentage of the time, we could still be profitable.  Below is the chart of the what transpired after CLJ19 touched the level.

Stock chart showing the supply zone, stop and target for a trade on crude oil

A given in our trading process should be that low risk entries always take into account the fact that we’re not always going to be right, and therefore, if we’re wrong we will lose very little (which very well could have happened here).

The next step once the levels are found and the risk to reward is assessed, is simply to place the orders in the market.  This can be done very easily on most professional level platforms. These allow us to simultaneously place (in the above example) a sell limit order to enter the trade, a buy stop, and a buy limit order to exit.

Free Trading WorkshopThe final step in the trading process is to manage the trade once it is triggered. This can be done by simply moving the stop to break-even once a certain target is achieved, or not do anything by being comfortable with letting it hit the target or stop out. The most important element in this step is to be as emotionally detached as possible from price movement. To achieve this, it is preferable that the exit strategy is well defined BEFORE the trade is triggered and that it is simple and comprised of a few adjustments.

That is a good starting point for a three step trading process that can be replicated and put into plan. Of course, it’s not as simple as I describe here because learning how to identify the highest quality low risk zones requires training and time.  If you have the motivation to learn, at Online Trading Academy we are here to help.

Until next time, I hope everyone has a great day.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.