How to Evaluate a Trade: Good or Bad?

 

 

 

When it comes to trading, the false belief many have is a profitable trade is a "good" trade while one that loses money is a "bad" one.

In reality, this isn't the case if ones goal is to develop good discipline in creating a trading plan that generates consistent profits.

Your developed trading plan MUST answer the following parameters:

1. Best entry value/range - this is your best predetermined entry area. This is critical as a good entry will have minimal whipsaw into loss area that can cause you to lose confidence in your trade.
2. Profit target - this is where you exit assuming the market moves according to your plans. You know the target in advance.
3. Stop Loss- If the market moves against your position, this is the value at which you have decided your trading plan isn't going to work out and you are exiting your trade to minimize loss.

It's important to note that the above 3 values are determined BEFORE you initiate your trade. In the age of super computers, thinking that you are going to have enough time to respond to market moves on the fly is a recipe for future disaster. Having your values set in advance puts your trade in cruise control. Either your trade moves to the profit target or it hits the stop loss.

Evaluating the Trade

Once the trade is completed you have two possible outcomes:

1. Winning Trade.
2. Losing Trade.

Executing the trade will also have two possibilities:

1. You followed the full trading plan.
2. You deviated from the trading plan.

This gives you four potential outcomes which will be the grade of your trade:

I. You followed the trading plan and had a winning trade

This is a clear good trade. You had a plan, properly executed it and the result was a winning trade.

II. You followed the trading plan and had a losing trade

This also falls under being a good trade. The trading rules were followed. Your next step here is to do some analysis to determine why the trade didn't work out- whether it falls within the expected win/loss ratio of your plan or if your plan needs adjusting.

III. You deviated from the trading plan and had a losing trade

This is a no brainer bad trade that can be expected from not following the trading plan.

IV. You deviated from the trading plan and had a winning trade

This is a bad trade and something many people get wrong by not realizing it. Not following the trading plan results in inconsistent actions and inconsistent results, and can reinforce bad habits. The trade being profitable in this case doesn't change the fact that the trading plan wasn't followed which is going to sabotage any hope of being consistent in generating profits.