Follow These Four Steps Before Rushing Into a Trade

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As a true multi-asset class trader, I could be trading stocks, bonds, commodities, or currencies during any given week.

And while each of those markets are different from one another – how I approach them is the same.

That’s because I only need to go through the same four steps and answer the same questions before taking a trade.

This simplicity allows me to be nimble and identify the best trading opportunities…

Four Questions to Ask Before Your Next Trade

Thorough analysis on each trade is vital for success. The following questions prevent me from rushing into a trade just because the market is moving…

  1. What’s the overall trend? Is it up, down, or sideways?
  2. What’s the chart pattern? Is it a trend continuation pattern or a reversal one?
  3. Does the momentum in the market back up my trend and pattern analysis?
  4. What’s my T.E.S.T. (timeframe, entry, stop loss, and target)?

I must clearly answer each question before being able to move on to the next. If I can’t answer a question, then I don’t have a great trading opportunity in front of me.

How to Apply This Process to Your Trades

Now let’s look at an example of how I put together a trade using these four steps.

Below you’ll see a coffee futures price chart. It’s a market I keep a close eye on because of how volatile it can be. Take a look…

Chart

Here’s how I would approach this chart using my four steps…

  1. The trend is clearly down. Since hitting its August peak, coffee has declined by nearly 40%.
  2. The chart pattern I’ve spotted is a potential reversal in the making.

    The Relative Strength Index (RSI) at the bottom of the chart is putting in strong signs of bullish divergence (blue line)… which happens when a market continues to trade lower, but the RSI begins to trend higher.

    The RSI bottomed out in November and has started to trend higher. At the same time, coffee has steadily traded lower.

  3. Strong bullish momentum is needed to confirm the potential reversal pattern from step two.

    That’s why I’ve marked a key level (red line) on the price chart. This key level comes in at $173.55, the recent high from December 28.

    If the market can trade through this level, then it would be a very convincing sign of bullish momentum.

  4. Now, we’re left with answering our T.E.S.T.

    Timeframe: This price chart is of the daily timeframe. That means that if a trade is triggered, then one could expect it to last several days or a few weeks.

    Entry: I would use a break of the key level to trade coffee. So, a break of $173.55 to the upside would be a great entry point.

    Stop Loss: The most recent low in the market would make for a great natural stop loss level. Right now, that would mean setting a stop loss at $142.

    Target: I would set a target around the 200-period moving average (MA – green line). Right now, that would mean setting a target at a price level of $204.36.

Always Stick to Your Trading Plan

And there we have it. A very simple and straightforward trading plan for coffee futures.

If coffee is a bit of an obscure market for you, then that’s OK. The bottom line is that you can follow these four steps on any market you choose.

This framework has helped keep me out of trouble over the last 14 years, and I hope it will serve you just as well.

Before you rush into a next trade, remember to slow down and have a trading plan in place.

Happy trading,

Imre Gams
Analyst, Market Minute

This article was originally published on this site