Preparation is the key to success in any field of life. Trading is not different. Here are three major questions every active trader should ask him/herself every morning/week.
1. Is it time to be short, long or on the sidelines and how aggressive should I be?
Are indexes overbought or oversold, do we see any momentum divergences, is there a good number of long setups.
What is the market reaction to earnings reports – do we see stocks selling off after strong reports or stocks rallying after weaker than expected reports. Nothing reveals the true market sentiment better than market reaction to earnings reports.
How aggressive should I be will define our risk per trade, the types of setups we will trade, how tight our stops will be and what our exit tactic will be.
What percentage of capital should I risk: for me it between 0.5% and 1% depending on the market environment. 0.5% in faster markets that change directions frequently. 1% in trending markets, up or down.
2. What type of setups should I focus on and why?
Do we buy strength (breakouts), do we buy weakness in established uptrends (pullbacks to rising moving averages), do we focus on recent IPOs, do we play a certain industry, should we look for mean-reversion setups, should we primarily look for short setups? Should we buy breakouts or could we afford to front-run and buy in anticipation of a breakout?
Holding period – should we be taking profits quickly (in 1-3 days) or let them run longer. How much room should we leave to our stocks? Where should we put our stops – make them tighter or leave them more room so we don’t get shaken out from normal pullbacks or rips.
Should we focus on intra-day trades or swing and position trades? For example, during deep market corrections volatility rises significantly and moves that typically happen in a month could happen in a day or two. This is the perfect trading environment for intra-day trades, because they allow us to risk very little to make a lot and we don’t risk to be on the other side of an overnight gap. During trending markets, we trading a market of stocks environment. Volatility is low and declining. The big moves happen over a period of multiple days and weeks. It makes a lot more sense to ride trends – be it with swing trades, which aim to capture 2 to 10% moves or position trades, which goal is to ride multi-week trends.
What industries are currently hot, if any? In a bull market, industry momentum accounts for half of a stock’s move. A crappy stock in a hot industry will outperform a great stock in an out of favor industry.
3. What are the three-four priority setups that we have lined up for the next day/week?