Wednesday, October 14, 2009

What every trade should have - the 3 E's

Whenever you go for a weekend trip, or want to travel somewhere even just to meet a friend somewhere, you need to know where you are going. Trading is no different. In fact, it is very important that each trade that is placed, is planned accordingly.

I don't remember who coined the term, but "Plan the trade, and then Trade the plan!". If you don't do your due diligence in any business endeavour (and yes trading IS a business endeavour), how can you expect to succeed? In planning trades, I always ensure that they contain the 3 E's.

E is for Entry
Where is it that you want to enter the trade? A specific price? A price level? A cross of two moving averages? What is it that says to you, "Hey! Here's the entry!"

All trades start with the Entry. It is from this point that the next two E's are derived.

E is for Exit 1
Exit 1, or Trade Exit/Take Profit, is the destination point. Where, in this trade, are you planning to go? 10 pips later, 20pips? Until the two moving averages cross against you? When the RSI breaks below 20 or above 80? Basically this is the point where you will want to close your trade, in full or just partial, and feel good about a successful trade.

E is for Exit 2
Exit 2, is there for when the market, although gave you some good indication your trade plan is going to work, just decides that, nope, not today, and then turns against you. If you haven't already guessed, yes, this is the Stop Loss. You want to protect your trading capital as much as possible. Stop Losses are there for when the trade plan, for whatever reason, just doesn't pan out.

I won't go into it here, but the Risk/Reward of the trade depends upon Exits 1/2. Ideally you don't want to be risking too much, for too little gain.

Jupiter Signals uses initial default Stop Loss values. 80 Pips for the AussieYen, 100 Pips for the EuroYen and 150 Pips for the PoundYen. These stops have been systematically tested to provide immediate coverage. The initial calculation is for approximately 1:1 Risk Reward, utilising two targets.

The initial Risk/Reward Ratio is calculated at targetting Target 2, the farther target. One way of mitigating Risk, is by moving the Stop Loss to Break Even once Target 1 has been reached. Target 1, through systematic testing has shown to hit far more frequently than Target2.

Lately, we have been in some particularly slow or range bound markets, with bursts of liquidity. Although the default Stop Losses are of considerable size (although appropriate or hourly charts) the stops can, and are often suggested to, be moved closer as the trade progresses - aka Trade Management.

Let's take a look at a good potential trade set-up.

There a lot on there but let me summarise below. This would be a VERY good Divergence entry at 143.15  That price level was alreadyan established level of resistance. Going back further you can see it also acted as support.

Divergence has formed twice. Now the orange line on price is horizontal, it is neither moving away from the indicator orange line, nor to it. Remember though, that Divergence (Convergence) is when price and the indicator are doing separate things. If you weren't too sure about that particular bit of divergence, then it was followed up with some more typical Divergence indicated by the red arrow.

So our trade plan would have had an excellent start. Even in the face of the Asian Session coming in, the odds were stacked positively in favour of a short.

The Blue circle is where abouts I opened the charts and saw price. Ideally 143.00 would have been a good entry, and had price retraced to that level, I certainly would have taken the trade. So why didn't I? I missed the boat. It already left the pier. I don't plan on getting wet, so I'm not going to take a running jump and HOPE that I land on the boat as it berths away from the pier (or is it only berth when it is docking?). Trade plans run on sound analysis, NOT HOPE.

Albeit for a system that targets 100+ pips, you might think 25-30pip late start is acceptable. But, let's return back to the 3 E's. Where are you going to now place the Stop Loss? In hindsight now, anywhere above that 143.15 mark is acceptable. But what if the market, from that entry point, then proceded to retest that 143.15 mark? There's a better entry right there, or, if you just jumped in with HOPE, there's -40 pips worth of movement.

Obviously in hindsight now with several hours since having passed and a good 100plus pips of southbound movement there, the whole what if scenario is moot. But each time you plan a trade, you need to take these things into consideration. Your Entry is an Entry for a reason. If you miss that Entry, then too bad. Move onto the next the trade.

Reminds me of another phrase, I think Dustin Pass used to (or still does) say, "Better to be out of a trade wishing I was in, than to be in a trade wishing I was out!". The latter part of that phrase is often what happens to people who miss the appropriate entry for whatever reason, and jump in anyway.

Thank you for your time.