Every second the markets are open presents an opportunity to trade, regardless of whether you trade stocks, FX, or futures. However, not every second offers a high-probability opportunity. Put each trade you consider through a five-step test to ensure you only pick trades that are in line with your trading plan and give a good profit potential for the risk you’re taking. Whether you’re a day trader, swing trader, or investor, put the test to the test.
It will take some practice at first, but once you get the hang of it, it just takes a few seconds to check if a trade passes the test, indicating whether you should trade or not.
Important Takeaways
Success depends on being disciplined, informed, and thorough, regardless of your trading technique.
We’ll go through five simple measures to follow before starting any transaction in this article.
Understanding your strategy and plan, spotting chances to determine your entry and exit targets, and knowing when to abandon a losing trade are all examples of these.
The 5-Step Checklist to Make Great Trades
Step 1: The Trade Setup
The setup is the set of requirements that must be met before a transaction can be considered. If you’re a trend-following trader, for example, a trend must be present. A tradable trend (for your strategy) should be defined in your trading plan. This will prevent you from trading when there isn’t a trend. Consider the “setup” to be your rationale for trading.
Figure 1 is a real-life illustration of this. As seen by greater swing highs and lows, as well as the price being above a 200-day moving average, the stock price is trending higher. Although your trade setup may differ, you should make sure that the conditions are beneficial for the approach you’re trading.
If you don’t have a reason to trade, don’t trade. If the setup—your purpose for trading—is there, move on to the next stage.
Step 2: The Trade Trigger
Even if you have a purpose to trade, you still need a specific occurrence to signal that it is time to trade. Figure 1 shows that the stock was in an uptrend throughout, although some points within that uptrend offer greater trading opportunities than others.
Some traders like to buy on new highs (i.e after the stock has fluctuated or pulled back). A trade trigger in this situation could be if the price rises above the $122 resistance area in August.
Others prefer to buy on a pullback. In this situation, wait for the price to develop a bullish engulfing pattern or to consolidate for many price bars before breaking above the consolidation. Both of these events are exact events that distinguish trading opportunities from all other market changes (for which you have no approach).
Figure 2 depicts three potential trade triggers that could occur during this stock’s current upswing. The precise nature of your trade trigger is determined by the trading method you employ. The first is a consolidation around support, in which the trade is initiated when the price climbs above the consolidation’s high. A bullish engulfing pattern near support could also act as a trade trigger: When a bullish candle appears, a long is initiated. A rebound to a new high price after a pullback or range is the third cue to purchase.
However, before making a trade, make certain that it is worthwhile. You always know where your entry point is in advance when you use a trade trigger. A trader might know that a rally above the June high is a likely trade trigger throughout July. This gives you enough time to double-check the trade’s validity (steps three through five) before committing to it.
Step 3: The Stop Loss
Knowing your trade trigger and having the correct entry conditions aren’t enough to make a good trade. A stop-loss order must also be used to manage the risk on the deal. 1 A stop loss can be placed in a variety of ways. A stop loss is frequently put just slightly below a recent swing low for long trades and just slightly above a recent swing high for short bets.
Another strategy is the Average True Range (ATR) stop loss, which includes putting the stop-loss order based on volatility a particular distance from the entry price.
Determine the location of your stop loss. You can compute the position size for the trade once you know the entry and stop loss prices.
Step 4: The Price Target
You now know whether the conditions are suitable for a trade and where the entry point and stop loss will be placed. Consider the profit possibility next.
A profit objective is based on something that can be measured rather than being set at random. For example, chart patterns provide targets dependent on the pattern’s size. When purchasing near the bottom of a trend channel, set a price objective near the top of the channel; if selling near the top of the channel, set a price target near the bottom of the channel.
The EUR/USD triangle pattern is around 600 pips wide at its broadest point in Figure 3. When you add it to the triangle breakthrough price, you get a target of 1.1650. This is where the aim to exit the transaction (at a profit) is set when trading a triangle breakout method.
Based on the tendencies of the market you’re trading, decide where your profit target will be. Profitable trades can also be exited using a trailing stop loss. You won’t know your profit potential in advance if you choose a trailing stop loss. That’s good, because the trailing stop loss lets you to profit from the market in a systematic (rather than random) way.
Step 5: The Reward-to-Risk
Make an effort to only enter deals where the reward possibility exceeds 1.5 times the risk. If the price reaches your stop loss, for example, you should make $150 or more if the goal price is met.
Figure 3 shows that the risk (difference between entry and stop loss) is 210 pips, but the profit potential is 600 pips. That’s a 2.86:1 reward-to-risk ratio (or 600/210).
You won’t be able to assess the reward-to-risk on the trade if you use a trailing stop loss. When making a deal, however, you should examine whether the profit potential will outweigh the danger.
Avoid the trade if the profit potential is equal to or less than the risk. It’s possible that you’ll put in all this effort just to realize you shouldn’t accept the transaction. It’s just as crucial to avoid terrible deals as it is to participate in good ones if you want to succeed.
Other Factors to Consider
The five-step test functions as a filter, ensuring that you only take trades that are in line with your strategy and have a good profit potential relative to risk. Other steps might be added to fit your trading style. Day traders, for example, may want to avoid taking positions just before the release of key economic data or a company’s earnings. To take a trade in this instance, check the economic calendar to ensure that no such occurrences are scheduled for the time you’ll be in the trade.
The Bottom Line
Check to see if the conditions are favorable for trading a specific strategy. Set a timer to remind you when it’s time to act. Determine whether the gain outweighs the risk by setting a stop loss and a target. If it does, go for it; if it doesn’t, keep looking for a better deal. Other aspects that may affect your trading should be considered, and additional precautions should be taken if necessary.
This may appear to be a time-consuming procedure at first, but once you’ve figured out your plan and are comfortable with the stages, it should only take a few seconds to go through the full list. It’s worth the time and effort to ensure that each trade passes the five-step test.
