Last week, I tweeted what I see as my trade entry process. This was the tweet:
For every trade, I structure my process from 1 to 6. Each step isn’t possible without the previous one. Anytime, certain price action can invalidate the entire setup and make me abandon it.
1. Analysis
2. Directional bias
3. Trade plan
4. Entry filters
5. Entry criteria
6. Trade— (@smartfxlearning) January 4, 2019
Since then, I got so many questions that I wanted to take a moment to write in more detail how I use this process to make better trading decisions.
Process -> Structure -> Excellence
The one reason why we go through all the trouble to define and follow a process is that it provides us with structure. As a trader, decision making is already hard enough so if certain habits can help us avoid decision fatigue, it should be welcomed.
Repeating any process results in more structure, but also makes us better at it. If the process is a good one (which I believe this trade entry process is), then repeating this day in day out will eventually make it easier for us to take the right trades and adhere to the habits that define a professional trader.
Too often, I see traders act like cowboys. The proverbial shooting from the hip represents the impulsive behaviour of many traders. Sometimes, the bullet hits the target but more often than not, it’s completely lost.
As such, most of us are better served with a defined process. After all, lots of cowboys got killed in the wild west and you really don’t want to get killed in the markets.
In that sense, traders should aim to be more like a sniper: preparing and scanning the markets and only when everything lines up, we’re pulling the trigger. This trade entry process can help you with that.
Preface
For the purpose of this article, I have written out the 6 different phases of my trade entry process. In my day to day trading, I will always go through every one of these 6 steps before I enter a trade.
Some of the steps have been formalized into a routine that involves actually writing my observations and requirements down but this isn’t the case for every single step. However, when you just get started with using a similar process, manually writing down every step for every trade might prove very helpful. You want to be clear on what exactly it is that you’re looking for when taking trades.
Invalidation
For every step, I will define the right context and parameters that will allow me to potentially take a trade. Just as important, however, is to define the invalidation conditions: what will make you abandon this trade idea? Thinking about this will make it easier to stick to your initial trade idea and let the price come to you, instead of chasing the market.
Note that this doesn’t mean that you need to operate from a mindset of inflexibility. Based on the most recent price action, you can, of course, adjust your plan and act accordingly. But when you do so within the context of this trade entry process, it will give you the structure you need, instead of just improvising as we go.
But without further ado, let’s get started with the 6 step process!
1. Analysis
In the analysis phase, I am story building.
I will look at the chart from a neutral perspective: not trying to pick sides or look for trading opportunities, but understanding the story the market is trying to tell me.
In order to do this, I will go from higher timeframes to lower timeframes, on each mapping out the big levels. I will look at where supply and demand are in balance and where it is very much unbalanced.
Rather than looking for “setups”, I am trying to figure out how other market participants are positioned. Where is the big money joining the party? And at which levels are they participating?
For me, this phase is like having a birds-eye view of an army in battle. It’s not yet clear who won the war, but we can still learn a lot about both sides. Battles are repeatedly fought to gain ground over the enemy. Sometimes, one side succeeds but often, they have to retreat.
You discover who is involved and where the biggest battles were fought. If we’re lucky, we can see a glimpse of who might come out on top in the end. Once I have this mental picture of the story of a chart, I move to the next phase.
2. Directional Bias
In the second phase, I will start looking for a directional bias. This stage is as if I’m at the roulette table at the casino and I can either choose to put my money on red, on black or not bet at all. We want to choose a directional bias because we want to know if we need to look for longs, for shorts or simply stay out of the markets for the time being (until something changes).
Bullish, Bearish or Neutral
In the first phase I would not look for direction but right now, I will try to pick sides or decide that there’s currently not a side strong enough to choose, which is to say I would be neutral. Neutral doesn’t necessarily mean that we don’t take a position but it should adjust the types of trades we look for.
If I’m a trend trader and the market is completely flat or ranging, I don’t want to take a position at all. Then again, a neutral bias might be what I’m looking for as a range trader. It all depends on the type of trader you are.
Keep in mind that a directional bias is very much related to the timeframe you’re looking at! I might have a bullish bias on the daily but a bearish bias on the 1H charts.
How To Determine A Bias?
This is the million dollar question! And the answer is that there are many different ways to determine bias. However, there are a number of broadly accepted ways of choosing a bias that might help you along. Some of the more popular ways are:
Classic Highs and Lows Analysis
This one is pretty simple: if the market is showing successive higher highs and higher lows, it’s going up. If the market is showing lower highs and lower lows, it’s going down. This simple trend wave analysis method might be all you need:
Moving Averages
If I were to bet on what the most popular way is to determine bias, this one would be it. Either we establish a bias depending on whether the instrument is trading above or below a moving average or we can choose to use the crossing of two or more moving averages, to determine which way to look.
By the way, there is not a single best moving average and it’s far from a magical solution to everything, but popular moving average periods for establishing bias are the 20, 50, 100 and 200. Which one you choose will largely depend on the time horizon for establishing your bias: whereas the 20 moving average will work fine to capture medium-term trend swings, the 200 moving average will be more often used to capture much longer trends.
Popular moving average crosses are the 20 and 50, 50 and 100, 50 and 200 and the 100 and 200. Again, these are not the golden grail of trading but they can, however, help you with establishing a bias.
Daily, Weekly and Monthly Opens
The open prices of the daily, weekly and monthly candles are also popular ways to establish bias. Of all methods, this might be the simplest to use but nevertheless very effective. When the price trades above the open, our bias is bullish and when the price trades below the open, our bias is bearish.
Longer-term opens are usually more significant but it also depends on which timeframe you use to trade. If you’re trading on the 5-minute charts, a daily open might be the best choice. Then again, if you’re trading 4H charts, the weekly and monthly open might be what you’re looking for.
VWAP
VWAP is an indicator that stands for Volume Weighted Average Price. As an average of volume traded, it works similarly to a moving average. Whenever the price trades below VWAP, we can adopt a bearish bias and whenever the price trades above VWAP, we use a bullish bias.
Higher-Timeframe Direction
Finally, we can simply look at the general direction of the higher-timeframe charts. If we don’t get a clear picture on the 1H charts, then the 4H or daily charts might show more direction. We simply move up some timeframes and look at whether the price is generally trending up, trending down or stays flat (or ranging). That information can be enough to give us our lower-timeframe bias.
A Bias Is Not A Position (Or Even A Trade Idea)
Having a bias on a particular instrument doesn’t mean that it’s tradable. It just means that I believe there’s a bigger than 50% chance that the market’s direction is going in one way versus the other. Also, if you have a bias that doesn’t align with the strategy you’re trading, the best course of action will often be to just abandon the chart.
To go from that bias to a position is an entirely different matter! Potentially, the direction is clear but the price is too volatile to enter. Or you have a conditional bias: the price first needs to cross a specific level to change your bias from neutral to bullish (or bearish). If you trade specific chart patterns, you might be waiting for that chart pattern to emerge.
However, the directional bias is the first step to determine in which direction you should be looking, which will come in handy for the next step.
3. Daily Game Plan
Now that we have our bias AND if it aligns with our trading strategy, it’s time to look for ways on how to actually plan a trade!
In the daily game plan, I will act as the general of an army, strategizing on how to best defeat the enemy (i.e. get a profitable trade). The daily game plan is where I will have my trading strategy in mind and see what needs to happen for me in order to take a trade.
In the daily game plan, I will work on scenarios.
e.g. “If the price on the 4H crosses and closes above 110.25 and made a higher high, I will take a long position”
You want these scenarios to be as concrete as possible, avoiding vague language. Your game plan should be a blueprint on how to trade for that day and in that regard, should contain the following things:
- What you think will happen in the markets
- … and what actually happened
- Concrete trading scenarios (see above)
- When to enter what instrument on what timeframe
- The reasons for entering
- Where to put your stops
- Where to put your targets
- How you are going to manage the trade – intermediate targets
- How to position size
- What might invalidate the scenario
- Economic news events that might influence your trading
- A comments section to note down anything that goes on through the day
The daily game plan should include entry filters (see 4) and entry triggers (5), either explicitly when written down or implicitly (when they are part of your trading plan). And the daily game plan should always be made before you start trading since it’s a good exercise to see how well you can come up with a plan and actually stick to it.
4. Entry Filters
Entry filters identify the setup conditions that precede a trade entry. They can be thought of as the “safety” for the entry trigger (see 5).
Once all of the conditions for the entry filters have been met, the safety is off and the entry trigger becomes active. Entry filters may include a variety of factors, such as:
- Price is above or below the 20 simple moving average
- Time of day is the first hour of the NY session
- Volume is at least X amount
- The recent candle close made a new 52-week high
- A head and shoulders pattern has been completed
So it doesn’t mean I automatically get in a trade when these are fulfilled, but it’s a prerequisite to even being interested in taking a position.
5. Entry Triggers
This is what makes or breaks a trade entry. When everything else lines up, entry triggers are what makes me decide to take a position or not. It’s usually a singular condition.
Trade triggers can be thought of as the line in the sand that defines exactly when a trade will be entered. Entry triggers are usually a single condition that either is or isn’t, in the most objective way possible. Before the entry trigger can be even considered, all conditions of the entry filters should be met.
Examples of entry triggers are:
- When a 1H candlestick closes below 1.24945
- When the price reaches a specific pivot level
- A candlestick pattern such as engulfing candle
When the entry trigger is fulfilled, I will enter a trade.
6. Trade Entry
At this point, all 5 points should be completely lined up and you should be comfortable to take the trade according to your trade plan and daily game plan. You might use an entry checklist to make sure you didn’t miss anything but other than that, you can just safely open the trade and let it play out. That’s it!
Conclusion
In this short overview of my trade entry process, I tried to give some more structure in the steps that are required to go from looking at a chart for the first time, to actually taking a trade. The steps are as follows:
- Analysis (the storytelling phase)
- Directional Bias (betting on red, black or staying out)
- Daily Game Plan (the army general who is strategizing)
- Entry Filters (the safety to arm your trade)
- Entry Triggers (what makes or breaks your trade)
- Trade Entry (off to the races!)
Do you have any other steps in your entry process?
Feel free to let me know in the comments!
