Successful trading boils down to making the right decisions and managing risk. But what does that mean? After all, it’s easy to point out after the fact what the right and wrong decision were. However, you can really boost your performance by asking these three simple trading questions before every trade.
Trading questions to ask yourself
What’s my edge?
One of the most important trading questions to ask yourself is: What’s my edge? As a trader you have to be able to clearly identify your edge. What is it that you do well? Is it trading low float stocks, earnings, breakouts, sector specific stocks, news events, catalysts, price action, momentum, mean-reservation or weekly options? Whatever the case may be, know your edge. know the type of trades that have proven to make you money. And honestly ask yourself, do I have an edge in this trade. If the answer is no, then don’t trade it.
Now, if you are new trading you might not know what your edge is yet. That said, you’re still experimenting and trying to find you what type of trades fit your personality. For example, the trader who buys into strength has a totally different personality from the trader who is trying to buy when a stock is selling off.
If you can’t clearly identify your edge…trade small. If you are trying to something new… trade small. If you know what your edge is you can explain why the trade opportunity looks good and have examples of similar trades that have worked in the past. Win lose or draw its a trade that you would do over again because you have an edge.
What’s my plan?
So you know that the trade looks good but what’s the plan? What levels are you looking to enter and exit at. How will you be sizing this position, everything all in at once? Or do you plan on scaling in? What is your decision making based off? Is it an event, time frame, volume bar, price point or what? It’s important to have levels in mind. If you don’t you could be riding an emotional rollercoaster if the trade starts working against you. Better to say: I’m getting in here, I’m looking to get out if it reaches this level if I’m right and if I’m wrong get out at this level.
Win lose or draw, traders always have a plan.
What is not a plan?
- I think this stock is down a lot so I’m going to buy it.
- This is trending higher so I am just going to buy it.
- The analyst on TV said this was a buy.
- The news seems very bullish/bearish.
- My buddy just got in this stock so I’m just following them because they always make money.
A plan must involve more than just I think the stock is going up or down. If you don’t have a clear plan then you let your emotions get too involved in the decision making. Instead of taking a small loss… you might hang around “hoping” that the trade reverses in your favor. How about you set a level to get out, but then decide to change it because you simply don’t want to take a loss on the trade. It’s a lot easier defining your levels before you’re in the trade. It will help in making your decisions more mechanical than emotional.
Here’s a look at a sample trading plan:
Risk vs. Reward, does this trade make sense?
For some people with small accounts trading names like Amazon.com, Google, and Priceline.com is out of the question. The spreads on these stocks are fairly wide and you need a cushion to withstand a move against you. So that’s one thing, does trading this stock make sense for my account is a question you must answer. It’s not all about high priced stocks either, you have to take into account volatility. For example, some biotech stocks have such wild swings that they are not suitable for all accounts. You might have to drawdown a decent amount before you can potentially make a profit.
Looking at the width of the bid-ask spread and volatility of a stock are good ways to figure out how much you should position size a trade. In addition, you have to look at your potential gains. For example, drawing down 5 points to potentially make 1 or 2 is a bad trade, but some traders foolishly take them.
You need to take trades that have been proven to have an edge for you. If you’re unsure, then trade small. Once you know what the edge is, you have to be strategic with your decision making. For example, can you clearly define what your outs are or are you unsure. If you find it hard to put a line in the sand, then most likely that is not a trade you want to be in. Also, you need to take into account what the risk vs. reward is and if it makes sense. You want to risk pennies to make dollars not the other way around.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks.