The 3-Step Framework You Should Use For Every Trade
Never get confused again
In trading, very few people have a smooth start. If you ask any successful trader about their career, it usually includes losing huge amounts of money and blowing up accounts at some point. To get where they are now, they needed to constantly unlearn what they believed and adopt the right ideas.
Eventually, they built a strong foundation that no one could take away from them. When you’re doing things the right way, you’ll eventually end up where you want to be - without much luck involved.
This is what we aim to do in this newsletter. Our first step is to build a strong foundation. It’s also the most important because it’s what you’ll build everything else on. If your foundation is weak, everything collapses.
We’ve already discussed how to organize your charts:
And the path you need to follow to make money from trading:
Now we’ll talk about how to find and execute your trades properly. You won’t be overwhelmed and confused when you’re looking at a chart because you’ll know exactly what you want. There are 3 steps you should follow before you take every trade:
1. Setup
As we know, markets are random and chaotic. If you don’t know what you’re looking for, you’ll get lost in the storm. You need to narrow it down and find market conditions that favor your setup.
If you’re a pullback trader, you specialize in buying the dip and/or selling the rip. If you see a market that’s ranging or has choppy price action, it’s not worth trading. You should only look for markets that have clean, trending action. This is where your trades are most likely to work out and give you the highest return.
If you’re a range trader, the opposite applies. Don’t try to short a market that’s trending up strongly and don’t buy a market that’s trending down strongly. Doing so will only get you burned. Your setup will only work in the right environment.
Let’s say you’re a pullback trader and you’re looking at this chart. We can see that price has been trending down for a while, consistently making lower lows. Price has also pulled back to our trendline. Is this a good setup to short?
There are other factors we’d need to consider like support/resistance, but for this example, it generally looks like a good setup to trade. Now that we’ve found the right environment, we can move on to our next step.
2. Confirmation
Confirmation tells us that our setup is playing out as intended. It’s important to balance this out. In our example, we need confirmation that price won’t reverse upwards and is more likely to continue downward.
Some ways we can confirm include price not going above the trendline and beginning to reverse. We can also use an indicator as extra confirmation. The more factors we have on our side, the better.
Timing is critical. If you take the trade without enough confirmation, it has a higher chance of being wrong. If you wait for too much confirmation, you’ll miss most of the move. I’ll expand on how you get your timing right in a future post.
For now, let’s get back to our example. We wait until the next candle appears, which is a large red candle that rejects the trendline. This tells us there’s not much momentum from buyers at this critical level. The RSI is showing a divergence with price (green lines). The price was not able to make a higher high along with the indicator. It would be safe to assume that sellers will take over and keep pushing the price down.
3. Execution
Now that our setup is confirmed, the final step is execution. We need to enter the trade properly so we can take full advantage of the move. I would recommend a limit order. Entering with a market order will get you a bad price.
We have our limit order, with stop loss and profit target ready. Our stop loss can be right above the trendline and our profit target should be where we expect the next move to end:
Now we let it play out:
The trade didn't go exactly as expected, and that's alright. Our stop loss almost got hit and we left a lot on the table after we took profit. This is realistic, as most trades won’t play out exactly how you want. You rarely get a perfect entry at the top and exit at the bottom.
As long as you’re in profit, you should be happy. For every trade you take, ask yourself these questions:
Is there a clear setup? If not, don't even bother looking. The noise can be confusing. You'll begin to see setups where there are none, like seeing water in a desert.
Once you've identified a setup:
Is there confirmation?
Is there something telling me it's more likely to continue in one direction than the reverse?
Is price action looking healthy/clean?
After this, all that's left to do is to execute well with a proper stop loss and price target. There you have it! You've logged in another great trade. Once you master all three of these aspects, you can simply rinse and repeat for profit.
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- Tradewriter
Disclaimer: Any content from this newsletter should not be taken as financial or investment advice, but for informational and entertainment purposes only. This newsletter simply shares my personal opinions. Investing in stocks, bonds, futures, options, and other securities carries significant risks. Some or all capital may be lost. With leveraged instruments, losses may exceed initial capital. Past performance of a security does not guarantee future results. Consult with a registered financial/investment professional. This newsletter and its authors are not licensed financial/investment professionals. By reading and using this newsletter, as well as any other publications, you are agreeing to these terms.