The Three Things You Need to Know Before the Trade

Friday, Jun 8, 2012

The Three Things You Need to Know Before the Trade

 

Many times trading gets boiled down to the entry, the profit target, and stop loss. Sure, these are important, in fact they are the building blocks of a trading plan, but they aren’t all that you need to know. Quite frankly, they are the last three things you need to know. So then what are the first three things that you must do before the trade? These first three things are the most influential because they determine the following:

 

  • Which pair you will even consider for a trade
  • Which direction you will enter a trade
  • Which time frame to focus on
  • Which strategy to use
  • How much risk tolerance you will need

 

The last step of a trade – the last thing you need to consider – before the entry is your risk to reward ration but all-too-often this becomes the point at which traders begin their trading plan and it’s why so many traders struggle. Unfortunately it’s because they don’t understand the larger forces at work: the risk environment, the economic environment, and the dominant psychology of the symbol they are trading.

 

We’ll examine these broadly in this article and re-visit this topic in more detail in the future, but let’s start the conversation now.

 

  1. Economic Calendar - Before the trade, any trade, I make sure I am keenly aware of the economic calendar and dominant headlines not just for today but what happened while I was away from my trading computer. For economic releases that means looking at the week in its entirety with particular emphasis on the session that proceeded, the current session, and what the market could be looking ahead to. For the headlines, I will look to sites like Forex Factory and Bloomberg to see what traders are reacting to and therefore discounting into the market. This allows me to gauge the potential risk of the session, when volatility is most likely to increase, and what time frames I will consider in this environment.
  2. Directional Bias - Time frame selection is determined in great part by identifying the Directional Bias in the market. Whatever symbol you are trading, the daily time frame is the first consideration and not necessarily for a trade, but to know what the dominant psychology of the market is. This is done by using my 34EMA Wave and GRaB candles. By understanding the sentiment, momentum, and trend in the markets you are actually identifying whether it’s the bulls or bears or NO ONE who’s in the driver seat. Trending daily time frames have what I call a “trending Directional Bias” and that is the best type of market to focus your efforts on because there is a clear, dominant psychology. You want someone behind the wheel. You really shouldn’t care if it’s a bull or bear (you didn’t know bulls and bears could drive!?)  If there is a trending Directional Bias, entering a trade with the trend is valid across all intraday time frames, and of course on the daily itself. However it would be best to limit counter-trend entries to only short-term time frames like the five, 15, and 30-minute. It is always the path of least resistance to follow the trend and therefore better to trade a symbol that has a trend on the daily.
  3. Cost per Trade - Another aspect of a trade is cost and pip movement. Many traders do not factor in the cost for a trade before they enter in terms of understanding the spread – and this can change slightly for each of the major sessions. Cost per trade can also include rollover if applicable to your trading account and depending upon how long you hold the position. Longer-term time frames are not impacted as greatly by a short-term time entry and may be reconsidered if the pip movement doesn’t justify taking the trade because of the spread. Pip movement ranges are part of that same discussion. Each market has a rhythm of its own whether we’re talking about a stock, futures contract, or forex pair. For forex, I know exactly what the expected pip movement range is for each pair I trade during each hour of the day! This is a must. Consider this: If a trader were to reference the hours between 8:00am and Noon EST and use that as a gauge for pip movement for 8:00pm to Midnight, their expectations would be severely off the mark since the pip movement between the European, U.K. and U.S. overlap can be (sometimes) twice that of the Asian session.

Keep these three things in mind as you prepare to enter any trade. For more education and analysis, check out the dailyforextradingedge.com.

Posted By: 

Raghee Horner

Raghee Horner, chief currency analyst for IBFX, provides her personal daily trading tips and insights through Dailyforextradingedge.com. An experienced trader with over fifteen years in the markets, Raghee is the co-founder of EZ2Trade Software and has taught her brand of technical analysis and charting strategies to students all over the world. She is an international author and has taught currencies, futures, and equities trading for over a decade.