Traders and investors in these modern times indulge themselves in trading without formulating a viable strategy that will assure them of maximum returns. Even so, it is important to develop a technique that will ensure you are consistent in your trading expertise. A good strategy will enable the trader to understand challenges, pitfalls, and how to improve on future trades. A good strategy is not an add-on process. That is, you don’t develop the strategy during or after a trade but before. It should be understood before you indulge in the trade, then you can begin investing. For purposes of this article, we will limit our investment to trading stocks and other securities.
Important points to consider
Have a checklist of the items you want to consider before you begin the trade. This list will help you eliminate any unnecessary items that are not relevant to the trade. As soon as you have this plan, pay heed to the following things below.
Identify the markets you intend to trade
There are various markets such as commodities, stocks, forex markets, and indices. You can choose among these based on your preferred list. Understand the basic things that drive these markets.
For example, if you choose the forex market there are various major currencies that you can trade. They include the euro, the Japanese yen, the Canadian dollar, the Chinese yuan, and the British pound. Indices include the US dollar index (DXY), S&P 500, or the Australian ASX 200 among others. Commodities include crude oil futures (WTI crude or Brent), metals like gold, copper, silver, and agricultural products such as soybeans or corn. Finally, some stocks represent shares in companies. As an investor, you will need to identify your strength and desire in any field. In the interest of time, it is important to be an expert in at least one or two markets to maintain proficiency.
Set the time frame
A trader should focus and not be carried away by the real-time data and the short-term charts. Investing requires the trader to identify a trend that may be from the past few months or weeks. Prior trend analysis is important in charting an investment strategy. Others tend to look far too short or too long without comprehending the time analysis as a tool of trading.
Let’s say we’ve settled on the forex market, and our currencies are the euro vs. the US dollar (EUR/USD).
EUR/USD (1-year) forex chart
Now for educational purposes, we will use this 1-year chart (2020-2021) to show the price movement of the EUR/USD trading pair. Our focus will be from March 2021. However, we need to consider the price movement between November 2020 and January 2021. The price was consistent at this time, indicative of a strengthening euro currency against the dollar. Such a timeframe means that we cannot bet against the euro in the long-term before we understand the fundamental shift that may affect the currency.
Additionally, from January 2021, the US dollar was gaining strength against the dollar with little retracement levels caused by a rising euro. Understanding this timeframe will help us to plan when to buy or short the currency pair and the time to execute the trading strategy. A look at the chart also reveals that at the beginning of every month – from January to March 2021, the price of this pair has been falling and then rising mid-month.
This analysis is crucial in planning a short strategy in April 2021. However, this situation may not hold, and we will need to keep watch and understand the real-time data that is available. Further, the chart is a daily chart; you may choose to use a 1-hour or 30-minute chart and see the difference visible with the candlesticks.
The trader should plan a stop-loss position before executing the trade. Investing is weakened when the trader starts to trade then starts to worry about where to place the stop-loss. It leads to a waste of time and may cause a great loss of funds if not checked. A look at the trendline will tell the investor if the market trend will continue or cease. Understanding the market will help in placing the stop-loss where it is required and shun any noise.
Let’s say you are planning to short the EUR/USD pair at 1.18965. Analysis of the prior price trendline will help you in designating the right stop-loss position. In our chart, we have identified the area around 1.18334 as a good target. In case the stock finds support at the 1.18965 regions and instead of going down reverses upwards then the stop-loss position will be at the 1.19859 marked zones (upwards). However, we have to keep in mind that the stop loss is placed in one position first based on how you intend to trade. If you plan to go bullish, place the stop loss below, and if you plan to short, place the stop loss at least 15 pips above.
Consider the financial risk
A good strategy involves risking no more than 3% of your account balance in any trade. This strategy is consistent whether you have $100 or $3 million in your trading account. For example, if you have $1,000 in your account and you plan to execute a trade, make sure that you only trade with a maximum of 3%. At this point, you are risking only $30, and you will have the rest to proceed with the trade, i.e., $970. Risking 15-20% is overzealous as trade patterns may change quicker than expected. A good trader values the number of trades as opposed to the amount gained. More exposure helps in building consistency.
This article has explained a unique way of investing that is based on the non-technical individual analysis. The investor should have a checklist of the market expectations. The items discussed here are not add-ons and should be integrated into the trading pattern before the execution.