Well did you make money or lose?
This has got to be one of the most common questions I’m asked and probably one that most traders get stuck on: What’s the difference between a good trade and a bad trade?
This tells me two things about someone when they ask me this question:
1. They have no real trading experience & basically no idea what they are doing. I.e: No trade plan, no capital management, don’t understand why the currencies go up and down……they are trading like it’s a sports betting market.
2. They have already lost a cart load of cash & will not last much longer. This is usually the question they ask before they run out of cash! (They need the vital piece of information to survive 1 more trade)
OK so let me break it down for you.
What’s the difference between a good trade and a bad trade?
Put simply, a good trade has made cash and a bad trade has lost cash. It’s that simple, but unfortunately that’s about as far as most new traders get!
All those dreams of a new house, paying off the mortgage, paying the kids school fees, a new car, exotic holidays, etc etc all blown away because they never worked it out.
Let me wind it back a notch first.
You have to understand what you’re doing. Understand the core elements of what you’re doing. Sure you are trading foreign exchange but that’s only the underlying asset class.
What you’re really doing is TRADING RISK!
And risk requires respect. It requires a plan. If you sure as hell don’t give it some Respect then you’ll become another negative statistic quick smart.
So back to the question….. sure a winner trade is good but is 5 or 10 points going to give you what you want? (All those gorgeous things I mentioned before)
The answer is NO.
So let me focus on the true essence of a good trade.
A good trade has a lower risk (there it is again “RISK”) & higher probability of success profile.
How do you find such a profile?
Through a solid checklist. Think of it as a “Probability Enhancer Checklist“
1. You need specific Entry Levels….. ideally determined by technical trendlines (yes that’s right your silly charts!)
These are easy to find on any chart. This really is child’s play.
If you look at the chart above you can see where the trendlines are. The ENTRY levels are found by following the trendlines. Don’t over complicate things. Notice how the chart is ‘naked’? There’s no need to add anything else to these charts.
2. You need specific Direction. This is the tricky part for veterans let alone new traders.
Experienced traders ‘read the market’ by looking at the Fundamentals: economic data, central bank announcements and Geo-political events. And that’s why direction can often be hard to assess because there are a lot of variables to consider. If direction is not clear ‘stay out of the market’ or drastically reduce your trade size before you blow yourself up….. because no specific direction is the cornerstone to a BAD trade.
Inexperienced Traders ‘use indicators to determine direction. Yes that’s right, usually 3 to 5 indicators to tell them when to buy or sell. Hahahahaha it’s bloody crazy. But really they aren’t to blame as there’s so much ‘marketing’ out there saying this one wins 95% of the time etc etc…. blah blah blah…. it’s all crap!
Why are they crap?
Because they are not in real time. They lag by 3-4 hours and are static mathematical models. Why is that an issue? Well in case you haven’t noticed the market is a dynamic beast which can change directions in an instant (and often does on economic data releases), so the indicators basically can’t keep up with the market. If you use them you will be forever chasing your tail!
So back to the question: What makes a good trade?
Because the ‘Fundamentals’ are so broad it’s best to break them down into component.
A. Correlations (Do we have good trading conditions?)
The major currencies correlate with one another based on the way they are quoted (traded). I.e: the USD is either the first currency in the quote or the second.
So if everything is normal (good trading conditions) the AUD, NZD, EUR & GBP should all move in the same direction and the CAD & YEN should move in the opposite direction.
Simple right! Well this is the first thing that new traders miss. Often when the currencies discombobulate the correlations are the first thing to go out the window. This is a time to be cautious. So once again either don’t trade or reduce your trade size.
B. Range in last 24 hours (Does the trade have potential?)
On average over the last 27 years I’ve been trading, the majors when they are rocking & rolling only range 150 points a day. Now that’s the high to the low in a 24 hour period, not 9am to 5pm during NYK as a lot of people ask me.
It’s from the time the high or low is hit to the end of the move – now that may take 2 hours or it may take 24 hours…who know’s. But I’ll sure as hell tell you the currency will stop! Check your charts (which I’m sure you will & should) to check my info. Don’t forget it’s on average.
There’s one exception to the rule: Central Bank announcements – these puppies are 250-300 point days and it’s very important to know this. because on those days you widen out your take profits to capture the potential moves!
Now back the chart above. When you look at an entry level and say for this example we have direction you want to make sure the trade has potential. If it’s approaching the Entry level and the range has already been 120 pips or more I would cancel the trade or reduce the trade size. There’s nothing to say it doesn’t go but on average the currency is not going to give you an extra 70-100 profit points. Because it just won’t go 220 points on it’s own without a major push.
C. Long Term Trend & Short Term Bias
Remember the old adage “The Trend is your friend”? Well it’s bloody true and you’d be wise to remember it. If you can’t write it down and stick it on the side of your computer screen.
OK this is another easy one for your charts.
It will have both the Long Term trend and Short Term bias in the same direction.
You just want the currency moving in one direction. Not fighting the short term bias and/or the long term trend. For short term trades the short term bias is more important. Obviously for long term trades the overall long term trend is most important.
To find the Long Term trends go to your Daily charts and for Short Term bias go to your Hourly charts.
Now reading the chart is simple…. is the current price above or below where it was say a year ago? If it’s lower you’re in a downtrend and if it’s higher you’re in an uptrend…SIMPLES!
For the short term Bias you do the same thing but on your Hourly charts. Is the currency higher or lower then where it was yesterday?
If it’s as the same spot then you’d say it’s trading sideways with no bias.
Golden Rule with Trend trading:
- If the Trend is down then “sell on rallies” back towards resistance. Never go long in a downtrend.
- If the Trend is up then “buy on dips” back towards support. Never go short in an uptrend.
Put simply – Go with the Trend, not against it!
D. Momentum (Stochastics)
Do you recall my ‘indicator bashing’ earlier? If not… here;s a reminder “they are crap!” Except for one that I give a ‘little’ bit of street cred. It’s stochastics. This indicators calculates momentum in real time. It moves with the market and doesn’t tell me anything except gauges momentum in the price action.
I want to know when the currency is overbought and running out of steam and vice versa. WHY? Because all the bankers look at it and manage their positions according to it. it allows you to modify your plan and also gives you the tick of approval to get into trades at the critical entry levels.
Important Note: Stochastics alone does not get me into a trade. It’s the last piece of the puzzle, the confirmation if you like.
Also I only concentrate on levels below 20 and above 80 on the stochastic measurement. These are the extreme levels of overbought and oversold. Clearly if it’s above 80 it would suggest the currency is overbought and as the lines cross over buying is being over taken by selling. And vice versa on the downside below 20.
So it’s a simple measure. Now it can happen at anytime …..but I’m only interested when it occurs near my entry levels.
So in the chart above the green circle I have a potential trade around the support trendline. Is it OK to sell? Well if I trail down vertically below and check the stochastics I see it’s not in the oversold territory…so yes i am comfortable to sell! If for example it was oversold and below 20 and turning up I would not sell.
E. Any Economic Data Releases?
Now you’ve definitely got to keep an eye on the Economic Calendars. This is your guide to trading activity. Sure the markets are open all week but this is when momentum or short term direction can turn on a dime.
Now I know everyone doesn’t have an economics degree but you don’t need one. It’s a simple case of actual versus forecast.
If you get the ‘economic release’ in the same direction as the short term bias and/or long term trend then you’re sure as hell on a GOOD TRADE.
Now when it comes to Central Bank bias, this is usually factored into the Long Term trend of the currency so don’t worry your cotton socks about this.
Now there’s a number of other things you can factor into your checklist. But this is what your “Probability Enhancer Checklist” should look like:
Now there’s a whole range of additional things you can consider like time-zones, specific pair characteristics, confidence, trade plan and of course capital management but this list above contains the main things I focus on before every trade.
And coincidentally this is how the ‘Next Best Trade’ page on our website will be set up.
If you understand this checklist and the sequence you should go through and then make it a habit, you’ll be well and truly on the way to becoming a long term trader!
Which brings me back to the initial question: What’s the difference between a good trade and a bad trade?
ANSWER: A good trade has the characteristics set out in the checklist. Ideally speaking for a GOOD TRADE we are looking for a technical trade with a fundamental driver.
It has a Low Risk/High probability profile and will invariably put cash in your account.
But the key to becoming a successful LONG TERM trader is not focusing on this question. Is it going to be a Good or Bad trade??
Instead focus on the NEXT BEST TRADE and your results will take care of yourself.
Then you’ll be freed up to focus on entry levels instead of ‘is this trade going to make me a few bucks or not.’