There was a book I read, The Checklist Manifesto, by Atul Gawande. The book explores the practice of making decisions based on the pre-defined checklist.
Trading is a serious business and it shouldn’t be treated any less, so shouldn’t traders too take every action based on a checklist?
The book focuses on the use of checklists in relation to several elements of daily and professional life and in the book Atul examines how checklists could be used for better efficiency and consistency.
Here are some things that are part of my pre-trade checklist and I make sure to abide by it every single time before taking a trade.
1. Are you trading what you see or are you trading what you want to see?
There is a difference between what you see and what you think could happen in the market. Only trade what you see is happening right now. Don’t try to be a fortune teller.
Since technical analysis is more of a subjective thing, different traders can have different interpretations of the price charts.
It might happen often that a trader is looking at a pattern that hasn’t yet been formed, hence the pattern cannot be confirmed, but the trader still goes on to validate it and take action, only to see that it was a mistake.
Like I mentioned above, do not try to be a fortune teller, do not try to predict what pattern the price will make next, but rather allow the price to play out and then make a decision based on it.
Beginner traders or amateur traders often commit the mistake of trading what they want to see rather than what is actually happening. The best way to trade what you see is to have some confluences or confirmations.
I know that confirmations or confluences take time and price might move away from the best point of entry, but isn’t it best to be safe than sorry?
2. Does your trade plan allow you to take the trade?
What is a trading plan? It is a system that you have created after careful backtesting and it gives you a signal whether to enter into a trade or not.
The answer is a big no. You should not trade anything that you haven’t tested and isn’t in your trade plan.
Even if you took the moving average crossover trade and it worked out for you, it was simple beginner's luck. This luck might work out again too, but once it goes against you, you will have no idea how to react.
You can always sit at your desk and work out different and newer trade plans and then take trades based on them, but it is very important that you stick to your plan, always.
No matter how good the opportunity seems, no matter how much it lures or attracts you if it is not according to your trade plan, then, believe me, you will be better off if you ignored it.
3. Do you know where to enter?
Every time you get a trade forex signal according to your trade plan, you will always have a price level at which you must take the entry.
Now if you do not have any idea where to take the entry then I would sincerely suggest you step away from the trading terminal and revaluate your trade plan.
Entries are the basic part of trade plans and if you are unsure about it then you should work on it before you burn your hand in trading.
It might happen at times that you know exactly where to take the entry but you end up missing the opportunity, what should you do?
The most prudent action would be to let it go, do not take the trade. Late entries will mess up with your risk to reward ratio and you could end up risking more than what you stand to win if the trade goes your way.
4. Do you know where to place your stop loss?
It is a common behavior among not-so-experienced traders to set their take profit levels after taking the entry. What you should rather do is, place your stop loss before the take profit level.
Stop losses are crucial for risk management and it is one important component that makes a trading strategy robust.
Every trade must have a stop loss unless you are ready to incur heavy loss and have no regard for risk management whatsoever.
Your stop loss should be according to your trade plan and if you don’t have a stop loss incorporated in your trade plan then you should stop trading and work on your trade plan.
5. Have you sized up your position correctly?
Position sizing along with stop loss makes up for risk management in trading. The size of your position in your trades should be in line with your risk parameters, or the risk limits you have set for yourself.
Trading with a quantity that exceeds your risk limits will make you prone to higher losses while trading with a lower than the required quantity will fetch you lower profits.
Hence, the position size should be just right, and it should be according to your risk capacity.
A good trade plan should have a stop loss and proper position size and this ensures that risk is managed well.
6. Do you know when to exit and take profits?
This is the most desired thing for traders, exiting the trade in profits, or having their take profit orders getting filled. Even though it is not as crucial as the stop loss, take profit levels are still important in trading.
A trader must know where to exit from the trade or at what price levels should he look to square off the position.
If you have a well tested trade plan then you will surely have a plan for exiting trades. Now, some traders may exit the trades all at once, while some traders may have multiple levels where they would look to exit.
All this is subjective and it depends on the type of strategy the trader is trading and their trade plan. If your trade plan allows you to trail your stop loss, or to exit in parts then do it.
If your plan does not accommodate such exit plans, then just exit the position all at once.
7. Are you in the right state of mind?
This is one immensely crucial question that every trader must ask themselves before taking trades, but it is also something that very less amount of traders do.
I have mentioned several times in many blog posts and even have dedicated blog posts for the psychological part of trading, having the right mindset in trading will put you on the path to success.
Now, what is the right state of mind to be in before taking trades? Traders should be relaxed and not be in a hyperactive state. They shouldn’t be overly eager to take trades or else they end up taking poor trades.
They should be in a state of mind where they have the patience and should wait for the trades to come to them, rather than them forcing things.
Another thing to consider is whether you incurred a loss on your previous trade and whether you are in the zone for a revenge trade.
If you had a losing trade, it is completely fine, but if you want to take the trade to get some kind of revenge from the market then run away from your desk and come back only when you are relaxed.
If you had a winning trade, or have been on a winning streak for the past trades, and if you are on cloud nine and are feeling overly confident, then you should never forget the fact that a loss is always around the corner and that you should stay humble or else get humbled by the market.
Why should you ask yourselves these questions before taking trades?
You might have a question in mind as to, why have this checklist, why ask these questions. Well, as I discussed, checklists can help improve your consistency and efficiency.
The book that I mentioned above perfectly explains this and it is quite easy to understand. The author does an amazing job to convey the importance of checklists.
Checklists mostly ensure that the actions taken are practical and analytical. It allows one to keep things mechanical.
I have discussed the 7 questions that every trader must ask before taking trades, this is a checklist that you should cross off one by one, step by step.
Once you do this, you have ensured that your trade is a perfect one and it is completely in accordance with your trade plan and risk management plan.
The question regarding trading psychology and mindset will allow the trader to control emotions and avoid it taking the better of them.
These actions are not discovered or introduced by me. These things have been done and followed by some of the most successful traders that have been there.
If you are to read about such legendary traders, then you will understand that it is not just the buying and selling of financial assets that make the trader successful in their endeavors, but it is these small yet impactful things they do other than buying and selling, that ensures that they achieve that level of success.
Do you have any pre-trade checklist?
These are some questions that I always ask myself before taking trades, you can choose to follow this and also have some additional questions that you can add to this checklist.
Do let me know your take on this and whether you would add anything further to it.
Feel free to reach out for any query or anything in general, I will be more than happy to engage with you all.
Don’t forget to share this blog post with others and let them also benefit from this system of checklists.