I have to give a presentation tonight so I am posting early.

Yesterday I suggested certain questions we ought to ask ourselves before we take a trade. Today I’d like to take the preparation, ‘the opening move’, one step further.

The questions help the analysis for the trading plan and for the risk management plan. They don’t apply to scalpers and perhaps some of the very short term traders (1 to 3 minute charts) - simply because this group trades predominantly on feel rather than cognitive considerations. For other timeframe traders, the questions satisfy our cognitive requirements prior to a trade. They are asked after determining whether to be long or short and for what instrument.

But that’s only one step of the preparation.

The second step engages our creative/emotional side. I ask my students to visualize:

  • the execution of the entry (including size) and
  • the execution of the exit strategies: initial stop, subsequent management and successful conclusion. By this I mean that we ’see’ a successful end to the trade - where we exit our core profit at our target. We also see ‘what the trade has to look like to remain in the trade’ etc; we also see the trade proving to be a failure - we ’see’ the initial stop being hit and we ’see’ occurring the conditions we ‘need to exit the trade’.

It is important that we accept the profits and losses as planned. I believe the reason why most traders fail to place stop losses in the market is because they subconsciously carry an image of the stop being and only to have the market resume moving in our direction.

But, if we change that image to one where after the stop is hit, the market moves against us big time, we are probably going to ensure the stop is in. Some of you may recall the trauma suffered by the High Probability Trader in the Societe Generale induced meltdown. He kept looking for a rally that never came and had to close the account. If you saw the video, use his image to spur you on ensuring you place a stop - ’see the market continue to move against you after the stop is hit’.
Let me say this again: it’s that important.

Behind the physical act of placing the stop, is the psychological acceptance of the loss. If you approach position sizing in the same way I suggested in the previous blogs, you’ll automatically include an assessment of the risk for the trade. If you use another approach, I recommend you add a risk:reward assessment to the preparation. Once you know risk, it’s important you accept the risk as a loss. In my own trading, I use Ed Sekoyta’s suggestion to treat the loss as already having been incurred. If you believe this ’story’, acceptance is a fait accompli since it ‘has already happened’.

Tomorrow we’ll proceed to the role of time in trading decisions.

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