If you are a trader, there are no shortages of opportunities to trade. In fact, you can trade almost every second of the day. But, that doesn’t mean that you should. In fact, every trader should have a trading plan before they begin and every single trade needs to be put to the test to see if it fits with your trading plan. This will consider its profit potential and its possible risk to determine its likelihood of becoming a successful trade. As a beginner, the 5 tests every trade must pass prior to trading will take some time and practice to go through, however, as you become more experienced, this process will become much faster.
- The Basic Conditions for the Trade – This needs to be compared to your style of trading and your trading plan. Examine the basic conditions of the trade and make sure your requirements are present. For example, if you are a trend following trader, then the trend must be present for you to consider a trade.
- Your Trade Trigger Must be Present – Even with all your basic conditions met, your trade trigger must be present. The trade trigger is the element that tells you that now is the time to trade. This entry point tells you when it is the right time to trade according to your trading plan.
- Place a Stop Loss – Even with the perfect conditions for trading and the trigger present, you must have a stop loss. There are various ways to place a stop loss so you are not limited, but before you can calculate your position size for the trade, you must know the entry and establish the stop loss.
- Consider the Profit Potential – Knowing when to enter a trade is not the only important aspect about trading. Before you place the trade, you must consider the profit target. This is not random – it is measurable and tools can be used to determine this. Start by working out the tendencies of the market you are trading and then establish your profit target.
- Analyze Reward vs Risk – Even with all the factors in place for making a trade, you may decide that this trade does not offer a high enough reward vs risk. Aim for trades where the profit potential is 1.5 times the risk. If the profit potential works out to be close to, or lower than the risk, you should avoid the trade.
When analyzing any trade, it is possible to discover at any one of the points along the test that you should not make the trade. Especially at the beginning when this process takes time, this could mean that you go through the whole process and when you reach the final test, you realize it is not a good trade. But avoiding bad trades is just as important as making good trades so this testing process is vital to your success as a trader. And with practice, this will become a quicker process.