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General Trading Information


General Trading Information

If you are a beginner or an experienced trader, the theory you need to learn is that you have to "have a plan" when trading. Trading is a business of "containing risk" and "evaluating profit potential". Sure, there is some "guessing" that is done (we have to identify the future and no one really knows what's going to happen - right). But the practice of using technical analysis to help determine the "potential future price moves" has been use for hundreds of years. So, as we begin this section, I'm going to discuss trading in three parts - "Planning", "Technical Analysis" and "the calculated risk". These are the three components I feel we all MUST use when deciding to place a trade.

Planning your trade

The first three elements...

This process is very simple to understand - everyone needs to completely understand WHAT it is they are doing and WHAT is the likely outcome (good or bad). When I instruct my clients to "Plan your trade", I want them to be able to tell me EXACTLY how they will try to ENTER the trade, where their stop (or EXIT) level will be and where they expect to pull profits in the trade. These are the elements that all traders MUST learn to accomplish. Not knowing exactly what to expect from your trade can leave you in a very dangerous position.

So, let's recap a bit... What are the three elements you MUST identify before you decide to place the actual trade??

The First Three Elements of Planning Your Trade

How do you plan to execute your ENTRY trade (and Where)?

Where wil you place your stop/exit level/order?

What is your projected profit level (where you will exit your trade)?

If you can't identify these first three things, then you are basically flying blind - throwing darts so to say.

The purpose of forcing you to identify these three elements is so you can begin to PLAN how you attempt to trade this signal. Sometimes you have to adopt different strategies and possibly increased or decreased risk/profit levels. By identifying these levels and knowing what to expect, you can go into your trade knowing exactly what you are risking and what you hope to achieve. Let me give you an example...

My Example Trading Elements

Assume I found a buy signal in XYZ and it closed at $22 today. Also assume XYZ had been in a strong downtrend for many weeks (from $40) and had a recent low of $19.80. Let's also assume I wanted to trade 300 shares. This might be one way to plan our trade.

How do you plan to execute your ENTRY trade (and Where)?

First off.. because the recent low is $2.20 away from the current price ($22). I also know the markets often trend is smaller up/down waves and I believe I can increase my profit potential by trading with limit orders (expecting a pullback). This would be my plan for the entry trade..

Order #1 - Place a BUY LIMIT order @ $20.90 for 300 shares
Order #2 - Place a BUY STOPLIMIT order @ $22.50 for 300 shares
Both of these orders would be placed in an OCA (one cancels all) group - meaning the first order that executes would cancel the other.

Why did I place the order like this? The first order expects XYZ to pullback - thus reducing my risk in the trade and increasing my profit potential. If this order gets filled, I'll have only about $1 risk for the trade.

If not, the other order (which is $0.50 above the current price) may get filled. This order is basically a "fail-safe" order to allow my entry if the market begins to run upward.

What happens if neither of the orders gets filled in the next few days?? This is when we would re-evaluate our trade decision and potentially alter the entry mechanism a bit. We may choose to simply "go in" with a market order (especially if the current price is below $22). Or we might adjust our two existing order price levels a bit. Either way, it is important to have patience and "let the trades come to you" - don't chase trades.

Where wil you place your stop/exit level/order?

Assuming I got filled with my entry order #1, I would place my stop below $19.80 (at first). This is a support level that appears to be holding (meaning market price should attempt to stay above this level.

If I got filled with my second entry order, I would still use the $19.80 as a "key point", but I might now be able to widthstand the risk of almost $3 per share ($900). Another common method of placing stops (that I like to use) is to average the current three bars lows or highs. In this case (because we are trying to go LONG - we would use the lows (and include the current bar). Let's assume that value was $21.25. I would then feel comfortable with a stop level between $21~21.25 for this trade.

Everyone should understand that "individual needs and requirements" often dictate "how and where" you place your trades. I might trade a bit differently than others, but the theories I'm trying to teach you are universal, you just have to adopt "levels" that meet your needs.

Now, let's assume neither of my 2 entry orders got filled and I'm deciding to "jump in now" with a market order. The first thing I would do is go back to the chart and look at the current price action - obviously it did not come down enough to hit trade #1, nor did it go up enough to hit #2. So, it's kind of "drifting".

Thus, I could "jump in" and place a stop order (to protect my equity) at a level that I feel comfortable with. I know that $19.80 is support and I know the market is drifting a bit (but should continue higher). So, let's assume I "jumped in" at $21.65.. I might place a stop a bit higher than the $19.80 lows (to further reduce my risk.. also knowing if I do get stopped out, I could always get back into the trade again). Remember, this is a plan of calculated risk. XYZ has not run up yet, so we are attempting to contain our risk and plan for a future price move. So, let's assume I entered my stop at $20 - my risk is $1.65 (maybe a bit high for others, but remember.. our original stop loss was going to be about $3 - so it is much more "contained").

What is your projected profit level (where you will exit your trade)?

OK, this side of the trade we have not discussed much (yet). You know the stock came down from $40 to below $20 and is not back to $22 (or there about) . So, where do we place our profit target levels??

There are a few techniques that I like to use to help find these levels..

1. Use support/resistance levels to find locations where market price has stalled in the past. These can often be good levels in the future.
2. Find DOJIs on the chart.. These are other signs of support/resistance. So they can also be levels where the market may move.
3. Average the last 3~5 candle ranges and then multiply that level by 2 or three. For example, if the average range (high-low) for the last 5 candles is $0.62, then a decent (starting point) profit target would be $1.5~$2.0 (for short term targets.
4. Use Fibbonacci levels to identify potential price levels.
5. Use longer term charts (like weekly charts) to identify other support/resistance levels and trend channels. You might be able to find a level that was not visible on the daily or shorter term charts.

Now that we have a number of ways to find a profit target level and have already established our stops, we simply need to determine "what we want from this trade". Most of the time, it is best to pick something that is "reasonable" and not "totally unrealistic".

If my calculations are correct, we are risking about $1~1.5 for a potential gain of $1.5 or better. Not very good really, but still - lets assume we made the trade. Would you be happy with a $600+ gain in a few days/weeks if we were right?

Remember, we'll continue to re-adjust our stop levels as the trade continues. So, our risk will decrease over time. The PT levels can be re-adjusted, but I suggest traders pull at least 50% of their position at their original projected profit target levels - then let the rest run with a stop.

 

Dealing with the "TIME FACTOR"

Most traders often "forget about time" as a factor of their trades. Sometimes, they are right - other times they are wrong. I generally use time as a factor for the actions of the markets. What does all this mean??

Assume our BUY signal (above) happened yesterday and we tried to get into the trade for three days (without success). So, three additional days of "nothing" happened - is our buy signal still valid or not? This is what I mean.

The best advice I can offer is this... "Let the trades come to you". This buy signal is probably correct, but the timing might be a little off. So, chasing this trade right now might result in a loss (if we don't see any upward price action soon). One thing you can do if your original trading signal "runs on........" is to place a BUY LIMIT ORDER at a price level ABOVE the trigger price. This is a way of saying "I want to BUY this stock when the market begins to RALLY". You can still contain the risk values by using stops and you will still have a profit target in place.

The general rule for using the "Time Factor" is, if the trade does not move in the expect direction right away - don't freak out. Remember, the market moves in little up and down waves all the time anyway. The thing you want to consider though is "how do you adopt your trade to these new conditions"??

If you are already in the trade and it has gone nowhere, it is probably wise to tighten stops a bit - to protect agains un-needed losses. Remember though, stops that are "Too Tight" could get you stopped out with a loss just before a future move - so leave some room in your stops for the market to "fluctuate a bit".

If you are not in the trade, then you might go back to the top of this page and re-evaluate your entry mechanism, stops and profit targets.

Another VERY VALID form of analysis is to use the longer term charts for additional confirmation of the signals.

 

 

 
 
     
 

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