Advanced Stock Market Trading - Level 1_4. Setting up a Trade

Lesson 4: Setting up a Trade

As a trader, you must understand that you are not limited to only stocks. Rather, you
have a wide choice of financial instruments to pick from. These instruments include
Bonds, Forex (FX), Commodities, Options, Exchange-traded funds (ETFs), Futures,
and the current e-mini futures contracts i.e. the e-mini S&P 500 futures contract. Any
of these instruments you pick for trading must trade under good volatility and liquidity
so that you would have profit opportunities.

To start with

#Liquidity

This defines the ability to quickly and efficiently carry out orders of any size without
causing any notable change in price. To further expatiate – liquidity denotes the ease
with which stocks, shares, or contracts can be sold and bought. Liquidity can be
measured in terms of:

✓ Depth – How deep is the market, how many orders are resting beyond the best
bid and best offer?

✓ Immediacy – How fast can a large market order be carried out?
✓ Resilience – How long does it take the market to bounce back after a large

order is filled?
✓ Width – How tight is the bid/ask spread?

Markets with good liquidity will likely incline to trade with tight bid/ask spreads and
with enough market depth to fill orders quickly. Liquidity is important to traders
because it helps ensure that orders will be: filled, filled with minimal slippage, filled
without substantially affecting price

#Volatility

Volatility measures the speed and amount at which price moves up and down in a
particular market. When a trading instrument experiences volatility, it offers
opportunities for traders to profit from the change in price. Any change in price, be it
rising or falling, generates an opportunity to profit. However, take note that it is not
possible to make a profit if price remains the same.

It is essential for you to keep in mind that a trading plan developed and tested for an
instrument say e-minis, will not certainly perform well when applied to another
instrument say stocks. You may therefore need a separate trading plan for each
instrument or type of instrument that you trade – one trading plan may perform well
on a variety of e-minis. It is advisable and helpful for traders to focus initially on one
trading instrument, then add other instruments as their trading skills, and trading
accounts increase.

The Primary Chart Interval You'll Use to Make Trading Decisions

Chart intervals are often associated with a particular trading style. They can be
based on time, volume or activity. The one you choose ultimately comes down to

personal preference and what makes the most sense to you. That said, it's common
for longer-term traders to look at longer-period charts; conversely, short-term traders
typically use intervals with smaller periods. For example, a swing trader may use a
60-minute chart while a scalper may prefer a 144-tick chart.

Keep in mind that price activity is the same no matter which chart you choose, and
the various charting intervals simply provide different views of the markets. While
you may choose to incorporate multiple charting intervals in your trading, your
primary charting interval will be the one you use to define specific trade entry and
exit rules.

Indicators and Settings, You'll Apply to the Chart

Your trading plan must also define any indicators that will be applied to your chart(s).
Technical indicators are mathematical calculations based on a trading instrument’s
past and current price and/or volume activity. It should be noted that indicators alone
don't provide buy and sell signals; you must interpret the signals to find trade entry
and exit points that conform to your trading style. Various types of indicators can be
used, including those that interpret trend, momentum, volatility and volume.

In addition to specifying technical indicators, your trading plan should also define the
settings that will be used. If you plan on using a moving average, for example, your
trading plan should specify a “20-day simple moving average” or a “50-day
exponential moving average.”

#Rules for Position Sizing

Position sizing refers to the dollar value of your trade and can also be used to define
the number of shares or contracts that you'll trade. It's very common, for example, for
new traders to start with one e-mini contract. After time, and if the system proves
successful, you might trade more than one contract at a time, thereby increasing
your potential profits, but also maximizing potential losses. Some trading plans may
call for additional contracts to be added only if a certain profit is achieved.
Regardless of your position sizing strategy, the rules should be clearly stated in your
trading plan.

#Entry Rules

Many traders are either conservative or aggressive by nature, and this often
becomes evident in their trade entry rules. Conservative traders may wait for too
much confirmation before entering a trade, thereby missing out on valid trading
opportunities. Overly aggressive traders, on the other hand, may be too quick to get
in the market without much confirmation at all. Trade entry rules can be used by
traders who are conservative, aggressive or somewhere in between to provide a
consistent and decisive means of getting into the market.

#Trade Filters and Triggers

Trade filters and triggers work together to create trade entry rules. Trade filters
identify the setup conditions that must be met in order for a trade entry to occur.

They can be thought of as the “safety” for the trade trigger; once conditions for the
trade filter have been met, the safety is off and the trigger becomes active. A trade
trigger is the line in the sand that defines when a trade will be entered. Trade triggers
can be based on a number of conditions, from indicator values to the crossing of a
price threshold.

Here’s an example of a trade filter:

✓ Time is between 9:30 AM and 3:00 PM EST.
✓ A price bar on a 5-minute chart has closed above the 20-day simple moving

average.
✓ The 20-day simple moving average is above the 50-day simple moving

average.

Once these conditions have been met, we can look for the trade trigger:

✓ Enter a long position with a stop limit order set for one tick above the previous
bar’s high.

Note how the trigger specifies the order type that will be used to execute the trade.
Because the order type determines how the trade is executed (and therefore filled), it
is important to understand the proper use of each order type; the order type should
be part of your trading plan.

#Exit Rules

It's said that you can enter a trade at any price level and make a profit by exiting at
the right time. While this seems overly simplistic, it's pretty accurate. Trade exits are
a critical aspect of a trading plan since they ultimately define the success of a trade.
As such, your exit rules require the same amount of research and testing as your
entry rules. Exit rules define a variety of trade outcomes and can include:

✓ Profit targets
✓ Stop loss levels
✓ Trailing stop levels
✓ Stop and reverse strategies
✓ Time exits (such as EOD – end of day)

As with trade entry rules, the type of exit orders that you use should be clearly
stated in your trading plan. For example:

✓ Profit target: Exit with a limit order set 20 ticks above the entry fill price
✓ Stop loss: Exit with a stop order set 10 ticks below the entry fill price​

Note: If you set this up as a bracket order (OCO order), once one order gets filled
(either the profit target or the stop loss), the other order will automatically be
canceled. If you place the orders manually, remember to cancel the remaining one to
avoid an unwanted position.

#Getting Ready for Testing

When developing your trading plan, remember to include all of the important
elements:

✓ trading instrument(s)
✓ time frames
✓ position sizing
✓ entry conditions (including filters and triggers)
✓ exit rules (including profit target, stop loss and money management)

Note that, writing down your trading plan is only the first step in a lengthy process. At
this stage, it's still just an idea – or a template for the final product. You'll have to
thoroughly test your plan before putting it in the market.