Two Questions I Ask Myself
There
are two questions I ask myself before I enter any trade.
Unless both of these questions can be answered to my satisfaction,
then the trade simply cannot be taken. You
can ask yourself these questions in either order.
I will discuss them in the order I ask. The
important thing is that the both questions are asked and answered.
1. What if
I’m wrong?
I’ve yet to find a setup or
method that works 100% of the time. Most
don’t work more than 65% of the time. Some
of the methods I use aren’t even right half of the time.
The point is, I’m wrong a lot. It’s
important to understand how much money I’m going to put at risk, ahead of
time. This number may vary, based on the
time frame of the trade, market conditions, time of day, the amount at risk I
already have in my account, etc. Once I
decide how much I am willing to put at risk for the individual trade, I can then
determine my stop placement and position size.
This simple question helps me to think about the consequences of the trade
failing, so that I can formulate a plan to control my risk.
I then need to think about the second question…
2. What if
I’m right?
Whether it’s a scalp trade or
an intermediate-term holding, I always need to know what the potential gains
might be. I might look to see where the
closest resistance is, or how far past moves have gone to help me determine
reasonable profit targets. I also think
about how much I want to make in the trade before I’ll begin scaling out.
If I’m right about a trade and it still isn’t going to make me much
money, then I’m not going to take it. Once
I answer this question, I know what the potential rewards may be.
If you can answer these two
questions about a trade, then you’ve done a rudimentary risk/reward analysis. It could be as simple
as “I’m going to risk 20 cents on this trade, because if I’m right, this
thing could go to the moon, and I think I’ve got at least a 25% chance of
being right,†or “I’m pretty sure I could get a few cents out of this
trade, but there’s a wall of resistance just above that, and there’s no
reasonable level to place my stop nearby, so I’m going to pass.â€
The quick step of asking myself
these two questions before I enter any trade has saved me from making a lot of
dumb trades over the course of my career. If
you don’t already ask yourself these questions, I would encourage you to do
so. You’ll likely find that you become
much more selective.
The market pulled back a little
today, which after the recent run up, was expected and causes me no concern.* market.
Until there is evidence of institutional distribution, it still seems
that the long side is the easier place to make money.
Good luck with your trading,
Rob Hanna
*
See Monday’s article for “What
About Bob?†market explanation.