Now you have become more flexible in your trading. You no longer define yourself in such rigid terms as day, swing, or position trader. You have become more of a market specialist. You have found the few markets that you want to trade and you now find yourself open minded to the daisy chain effect that bears on the markets you watch. Are you ready to get started yet? Not quite. To develop an effective risk management strategy and to fully utilize the daisy chain effect to your benefit, you must be capable of identifying five core pieces of data. Three of them are lumped together: entry price, loss price, and profit price. These three prices are essential to determining if the risk of the trade is worth the profit potential. The second two pieces of information focus on time. It is essential to determine if you are trading with trend or the counter-trend. Which one you trade will effect the likelihood of you achieving your profit targets and also how quickly. Entry Price, Loss Price, and Profit Price No matter what time frame you attempt to trade in there are only three prices that every trader must be concerned with: the trade entry price, the loss target price, and the profit target price. Each one of these components must be determined in advance in order to confidently execute a trade and to decide ultimately what to do, whether the trade is failing or is successful. In ‘Winning the Trading Game’ we covered various technical analysis tools that help you determine how to effectively come up with the necessary entry, loss, and profit target prices. Knowing these numbers is essential to developing your flexibility as a trader and devising the proper trading strategy to approach the market. These three numbers alone will give you the necessary vision to determine the full potential of a trade. As with many trading suggestions, finding key prices is simple but not easy. Once established, they reduce your need for guess work. They become the facts and figures you use to design your trade. They illuminate what your potential losses and profits will be. At the same time, it is not necessary to be 100 percent perfect in choosing any of them. It has been said that W.D. Gann had an uncanny ability for forecasting trades. In 1909 a reporter witnessed 286 winning trades and only 22 losing trades. This gave Gann an accuracy of 92 percent. Too many traders believe they have to have these same types of results in order to be successful. The reality is far from it. Of the three numbers you need to know: entry, loss, and profit; your entry price is the least necessary. Markets move swiftly, and while you always want to get the optimum entry price, slippage can affect your fill. This phenomenon makes specific entry prices unreliable. It is better to use entry price as a guideline rather than a set-in-stone number. It is more important to know how you will exit a trade. Knowing your potential loss exit price and your profit exit price are essential and should not be afforded the same flexibility as the entry price. These two prices, loss and profit, are essential in calculating your potential loss and your potential profit. They are the best way to determine if the trade you are thinking of taking is worth the risk. The traditionally acceptable “risk of loss rule” is the willingness to risk one to gain two. While this equation can be effective in assisting traders in estimating what their potential trade success could be, it rarely works out. It is one thing to know what the numbers are; it’s entirely another thing to be able to trade those numbers properly. This flaw is not the fault of the trader—even though traders will typically blame themselves—but more so a fault of the tools at their disposal. The inaccuracy of using stops and limits by themselves makes it difficult to have any sense of control in your trading. With the problem of slippage, missed opportunities of limit orders, and the self-defeating nature of stops, they only get you out when the market has momentum against you. It is no wonder why so many traders are frustrated with them. With the limitations that stops and limits have, you want to minimize their overall use in your exit prices as much as possible. The more rigid you are in dealing with your exit price, the more likely you will succeed in the long run. This is the place where more emphasis should be placed by the trader, rather than in attempting to discover the best entry price. Trend and Counter-trend The trend and counter-trend are two more key components that every trader must be able to successfully identify. If you cannot determine whether you are entering a market when it is trending or counter-trending, how will you know where to place your primary trader? Knowing whether you are trading the trend or the counter-trend is paramount to which entry and exit prices you choose. If you are following the trend, you will have different time expectations than if you are following a counter-trend. Trends will typically lumber and meander towards their destination in fits and spurts, creating multiple opportunities for anyone to jump on at the appropriate pull back. Counter-trends typically behave differently. They are swift and aggressive and are actually the retracement opportunities that develop from the actual trend. There is fast money to make and lose during counter-trends. While they may quickly move against the trend, they lose momentum just as fast and turn back around to follow the overall trend once again. At some point trends and counter-trends converge and switch places. Where once a market moved steadily higher or lower, the counter-trend emerges, acting like a quick-release pressure valve. Then something changes, typically a fundamental shift in supply or demand, which pushes the counter-trend into new territory. It completely changes the rhythm and tone of the markets, thereby setting up new opportunities as the trend. This yin/yang cycle between trends and counter-trends is important to understand. It dictates how you interact with the markets and what tactics you set out using in order to gain the maximum effect. This is of monumental importance when deciding what time frame you would like to trade in.
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W.D. Gann, trade entry price, loss target price, profit target price, risk of loss rule, Trend, counter-trend,
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