Every day the markets open is an opportunity to trade and make the most of it.
While the possibilities are endless, not every trade will be right (or profitable) for you.
That’s why I like to put any trade I’m considering through a filter to weed out those that do not match my trading plan and objectives.
This test allows me to focus on those that have the potential to offer the best or a somewhat reasonable reward for the risk I take.
Here are five quick steps I run through before taking any trade:
Look Out For Your Trade Setup
First things first.
It’s common to be tempted to try something new or different when things aren’t going well or when you feel like you’re missing out.
You have to develop the discipline to stay focused. Because what’s the point of having a good plan if you’re not going to stick to it?
It’s important to identify your setup to even consider a trade. Think of it as your reason for trading.
You should make sure that conditions are favorable for the strategy being traded.
This is all based on your trading plan — which will define what setups need to be present for your strategy.
Wait For The Trigger
After you identify your setup, the next thing on the list is identifying a trigger.
It’s the signal that lets you know the right time to take action and enter a position…as well as where your entry point is in advance. What your exact trade trigger is will depend on the trading strategy you are using.
Before a trade is taken though, check to make sure the trade is worth taking. I like to wait for the perfect moment to pull the trigger on my favorite setups. But before that happens, I look to gain some income – in which case I prefer to minimize and spread my risk during lower probability plays.
And talking about risk…
Minimize Risk With A Good Stop Loss
One of the keys to staying profitable is keeping your losses as small as possible.
When a trade goes against you, especially when you’re dealing with volatile stocks, a stop-loss order is important to reduce risk.
Stop orders are a way of telling your broker to buy or sell a stock when it reaches a certain price.
It’s not enough to identify a setup and know the trade trigger. It’s important to manage and minimize risk with a stop-loss order.
There are different ways to place a stop loss, and I talk more about stop losses and risk management here.
What’s The Price Target?
After identifying your setup, spotting the trading trigger, and figuring out the entry point…
The next crucial step is to evaluate the profit potential and set a target. Your profit target is the price point where you’ll take your gain and exit a trade.
This isn’t just a made-up or random amount. It will most likely be based on the situation and trend of the market you’re trading.
As you know, the stop loss (I mentioned above) can be used to exit trades profitably. Note that when you’re using a certain type of stop-loss — like the trailing stop loss, you won’t know your profit in advance.
Weigh The Reward-to-Risk Ratio
Trading is a risky playground. And the whole point is to reap the rewards it offers.
Here’s a simple rule to follow:
If the potential profit is very close to or smaller than the risk, then move on. It’s simply not worth the risk.
Whenever I take a trade, I prefer the profit potential to outweigh the risk. As a general rule, I allocate no more than 20% of my account on any one trade. And at any given time, I try to have no more than 50% of my account at risk.
A profit potential greater than 1.5 times the risk sounds reasonable to me.