Choose your best trade.

It’s a simple idea – and one that is often overlooked.

When I tell traders they should only be trading their best ideas, I am normally on the wrong end of a very confused (and sometimes exasperated!) set of facial expressions.

“How do I tell if a one trade is good compared to another one?”

That is the question I am asked and it is the one we will deal with here.

To use an over-simplified example, here is a chart of the NZDUSD with an indicator coded to show a big arrow when there is a buy or sell entry.

Instead of looking to take every entry, which would result in getting chopped around, as a discretionary trader you would assess each entry signal to decide if you should take it or ignore it.

This applies to you no matter if you entry is as simple as the example above or more carefully considered. You still need to decide if it is a trade you want to take.

Far too often the processes traders have to make this decision are not that great.

But don’t let having to decide which trades to take intimidate you. With the proper framework, this can be a great way to improve your trading performance.

Does the trade fit your objectives?

The relentless search for the Holy Grail entry can sometimes leave the rest of the trading plan underdone. But without the context of a complete trading plan it is actually pretty tricky to figure out what trades to take.

As a trader you should know exactly how many trades you are looking to take in each day, week or month, and what you want to achieve from each of those trades.

If you have in your plan that you want to take three trades a week, and by Tuesday you are already on your forth, then you know something is likely wrong.

So the first question is:

“Does the trade fit my objectives?”

For more information on setting proper objectives you can go here.

You are a risk manager first

You are a risk manager first and a trader second.

Each trade should fit your risk management parameters.

In particular: do you have room in your portfolio for the trade? Does it correlate with any other trades? And does it create any unwanted synthetic positions?

 “Is it a good trade?”

Next, you need to assess whether the trade is of a high enough quality for you to take it.

For many traders, this concept it going to seem a little awkward.

The idea of selecting one trade over the other does not sit comfortably. But as a “rules based discretionary trader”, you have the luxury of filtering out the trades that don’t make sense.

The same applies for whatever you use as your entry signal. Instead of just taking it, assess it first.

Here is a list of things you can assess to determine if you should take the trade.

  • Risk sentiment. Look at the stock market to determine if we are in a risk-on or risk-off environment. Does this environment support your trade idea?
  • The price of commodities can drive currency pairs. For example gold and copper are important to the AUD. Milk powder to the NZD and Oil to the CAD.
  • Bonds and interest rates. Sometimes currencies will move in lock step to the bond market.
  • Strength vs. other currencies. If you are looking to buy a currency, does it show strength across the board, or is the signal a noisy blip on only the one pair?
  • Risk vs. reward. Does the trade fit your risk/reward parameters? Remember not to try and manufacture a superior risk/reward by making these mistakes.
  • Market type. The trade should be the appropriate one for the current market type, and the one you expect to come next.
  • Big picture global macro. Does the trade line up with the global macro environment? (This may not be so relevant for short-term trades).
  • Technical quality (Set-up). How good is the technical set-up? For example, if you are taking a reversal trade, is it off a key level?
  • Short-term news flow/fundamental catalyst. Is there a news event that has triggered the trade?
  • Upcoming news. Are there any news events on the horizon that could impact the trade? What do you expect the outcome to be?
  • Gut feeling (do you like it?). Do you have a good feeling about the trade? Does it seem like the right trade to take, or are you forcing it?

Note that this is not a time consuming process that over complicates your trading or creates indecisiveness, like it might seem on the surface. You already have all this information together before you stalk your entry.

It will actually make your entry decision faster and easier to make as you will have conviction in your trade.

Take only your best trades

So there you have it, a framework for deciding what trades to take and which to ignore.

While using this framework to assess trades may seem daunting, if you have the correct processes in place, it is a skill that can be mastered to great effect.

Having this framework will protect your profits, keep your losses small and give you a significant advantage over the competition.

But you just can’t avoid putting in the hard yards sometimes. This is one of those crucial skills that simply takes time and experience to get a handle on.

If you want to learn more about how to set up processes to support this framework specific to your trading, check out the Forex System Development workshop session this Sunday when we cover the approach in detail.

About the Author

Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders (get free access). He is the owner of a provider of Forex signals from ex-bank and hedge fund traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter.