In our last email we showed you how to successfully and safely navigate support and resistance levels to ensure you have more winners.
Now that you know how to successfully and safely navigate support and resistance levels you will want to know more about how other forms of context can impact your trades’ outcomes.
Assuming you have an actual trading edge that produces a meaningful percentage of winners, preferably an actual mechanical trading system, you need to be aware that there are factors outside of your trading system or method which can have a significant impact on your trading outcomes.
Context consists of all of the variables that are not part of an actual trading system, but which can have an impact on your trading. In our previous post we examined two of the most significant contextual variables – support and resistance.
One of the most overlooked contextual variables in trading is the timing of economic reports. It can be financial suicide to already be in a trade and have a major economic report announce its results that would run counter to your trade’s direction.
Some traders attempt to actually time trade entries based on anticipated economic report results. This rarely produces consistent returns. In fact, I once had a student who reported to me that before he had joined TradeSafe he had attempted to time the market based on economic reports and had lost in excess of six figures on a single trade.
What should you do? Prudence dictates that you stand aside until the report has been released and the market has returned to normal trading. It is advised that you stop entering trades within 15 minutes of a major economic report in order to give your trade time to mature and conclude since the average trade lasts about that long or less. If you were already in a trade and a report is about to be released, close the trade, regardless of your open profit or loss.
Which reports are considered significant and where do you find their schedule of release? There are numerous services that provide free calendars which list economic reports on a daily basis for each week, often including other incidents such as Federal Reserve members’ testimony or speeches.
One free recommended service that makes it easy to distinguish the significant reports from others that have little or no impact on trading would be Econoday. You can view their weekly calendar by clicking this link https://us.econoday.com/byweek.asp?cust=us
Another contextual variable is price overextension. Since no trend last forever, you will want to know what the average price move is (in dollars) for each market you trade as well as each time frame within that market. Simple back testing can reveal what an average price move would be for a given market or time frame.
As an example, in day trading the US indexes, an average price move on a three minute chart from beginning to end, is approximately $600-$800. This price move would have to be from a major pivot starting point to the point in the price move that the market has reached thus far.
If congestion has occurred along the way, then you have two separate segments separated by the zone of congestion. If this occurs, you would either measure from the top or bottom of the congestion zone to the endpoint of the final segment, or measure the beginning of the entire price move to the congestion zone itself. If either segment exceeds the average, then price is overextended.
For 1-minute charts and small setting tick charts (e.g., 144 tick), the average price move for the US indexes is approximately $500. Use the same approach previously described for measuring the price move in dollars.
In a given market, if any of the affected charts has exceeded its average price move then it can be considered overextended for that timeframe. This means that the probabilities of getting sufficient follow-through for a winning trade are not as good as if a trade were taken within the average price move range.
This can help you gauge when to stand aside if your trade’s probabilities, outside of your trading system, would be affected by context. Just as was recommended in our previous post regarding support and resistance, you can accumulate a reliable body of feedback by journaling every trade you take. Take note of exactly how a contextual variable impacted your trade’s outcome, either positively or negatively.
Although volume is often part of many trading methods or systems, it should not be overlooked even if your approach doesn’t have specific volume requirements for entering a trade. Simply put, you need adequate volume to get your orders filled.
It is advisable to Sim trade at first to gauge what minimum volume requirements would be for your trade size before risking live trading with your account. For the US indexes, excepting the ES which is very liquid but not very trendy, it is recommended that you have at least 100 contracts traded for each 1-minute bar. That is if you are trading up to approximately four contracts at a time.
Ideally, you would want to have at least 200 contracts for each 1-minute bar as an average to ensure good fills for trade sizes up to 4-6 contracts.
Once you start increasing trade size above six contracts, you run the risk of getting a split fill or not being filled at all if trading volume is not sufficient. That is why you should do extensive testing in sim mode before graduating to live trading.
Of course, excessive volume can be too much of a good thing if it is occurring within high volatility conditions. Please refer to our previous post on volatility for guidance on how to manage your trading during volatile conditions.
One of the most overlooked contextual variables by traders is trading psychology or discipline. We have all experienced the temptation of revenge trading or overtrading to make up for losses. The reverse can often be true – some of us will get analysis paralysis after one or more losers and be unable to take another trade without hesitation.
In previous posts, journaling was emphasized as a way of learning from your mistakes. Successful professionals all Journal their trades. If all you are doing is jumping from trade to trade without considering why your last trade succeeded or failed, you are doomed to be an inconsistent trader.
Pay close attention to your attitude going into a trade, during the trade itself, and immediately after the trade is over. Write out a synopsis of what happened to your attitude or emotions during that trade’s sequence so that you will be more aware of how these mental changes impact your trading results. You will soon see patterns emerging in your behavior and how they impacted your trading.
The more you build in structure and consistency into your trading routines the more consistent will be your trading results. It is not necessary to be obsessive-compulsive about your trading routines, but trading without consistent routines will cost you money.
This has been a sample of how contextual variables can affect your trading outcomes. It is not exhaustive, so you should notice any variable that is not an actual part of your method our system and pay close attention as to how much it is affecting your trading. The best tool for tracking these variables is journaling.
In our next installment we will examine the most overlooked and most powerful tool traders can use to lock in real consistency – Benchmarking.
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