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Being prepared to take decisive and timely action is key to being a successful trader. The inputs to making a decision must be quickly recognized in order to formulate your action plan. Defining possible scenarios, and training yourself to recognize market conditions is the first step in making the decision. Without a correct and complete assessment of the current conditions, and the possible outcomes, a rational decision can not be made.

 

I don't like being "caught by surprise". This article will attempt to define basic and generic trading situations and then list the questions that must be asked in order to make a good decision. I am calling this a "Decision Cycle", and it is similar to a decision making flow chart. I'm trying to create a guide that is precise and well defined. I can then memorize the "Decision Cycles" and train my mind to process market conditions in a very structured and unbiased way. The goal is to create a very mechanical and "robotic" decision making system, but hopefully not at the expense of common sense. For the decision system to avoid serious flaws, it must not have an incomplete list of possible trading situations. Included is a list of possible generic trading situations we might all find ourselves in.

 

In the past, I've created decision making documents that focused too much on details specific to my indicators and market conditions. This created an overly complicated and lengthy document that I ended up never using. When I changed the focus to something more generic and basic, I started to realize that there are only a few possible trading scenarios that I can get myself into, like, . . . "Did I make a good entry or not?" It's a simple and straight forward question. Nothing complicated. The analysis specific to my indicators can be slightly more complicated, but if I start with a simple question, then the decision making is more straight forward.

 

But before defining the possible trading situations, I'd like to just list what I'm calling the "Decision Cycle".

 

1. Establish current price direction and trend.

2. Establish the current status of your indicators.

3. Enter trade on signal

4. Determine which trading situation you are in, from the list of possible trading scenarios.

5. Follow the guidelines for that trading situation, and then branch and cycle through the decision making process.

6. Once critical and high priority decisions have been made, immediately re-evaluate the current trend and indicator status. Decide ahead of time what the possible next scenarios might be, and what possible combinations of different signals might mean.

7. Once a new trade signal happens and/or the trade is exited, re-establish what the current price direction, price trend, and indicator status is. Match the current market conditions and trade situation to your defined trading scenarios and follow the plan

COMPONENTS OF DECISION CYCLES

 

  • ENTRY
  • EXIT
  • RE-ENTRY - IMMEDIATE
  • RE-ENTRY ON RETRACEMENT
  • REVERSAL
  • GOOD ENTRY or GOOD RE-ENTRY
  • BAD ENTRY or BAD RE-ENTRY
  • GOOD EXIT
  • VIABLE, BUT LESS THAN OPTIMAL ENTRY
  • PROFITABLE, BUT LESS THAN OPTIMAL EXIT
  • BAD EXIT
  • TWO BAD EXITS IN A ROW
  • THREE BAD EXITS IN A ROW
  • STATE OF MIND CHECK
  • RESET

 

 

I don't think that the above entries and exit's need to be defined. They are self-explanatory. But I do want to note something about the "BAD EXIT"

 

  • BAD EXIT - I'm not defining a "Bad Exit" as a loss. You can't have 100% winning trades. So not every loss is a "Bad Exit", . . . it depends. A loss on a trade could have been an excellent trading decision. A "Bad Exit" is when you let the loss run more than you should have. And letting the loss run more than you should have is about making a poor decision. And making a decision in a bad situation is based upon how negative results affect you emotionally, and then how you deal with the discomfort. So a Bad Exit is defined as much by how well or poorly you dealt with negative results and discomfort, as it has to do with the amount of the loss. In fact, the amount of the loss is almost immaterial if it is within an allowable range of your strategy, and your strategy makes money.

 

Definitions:

  • Confirmation - An indication that the price is moving in the direction of your trade.
  • Reversal - exit one trade and immediately re-enter another trade in the opposite direction.

 

DECISION CYCLES

  • ENTRY
    • Enter on Signal
    • Watch for Confirmation
    • Confirmation happens
      • Manage trade - Switch to "GOOD ENTRY" cycle

      [*]Confirmation does NOT happens

      • Exit or reverse immediately
      • Switch to "BAD ENTRY" cycle

     

     

     

    [*]EXIT

    • Before the exit happens, determine whether the next exit could be a reversal point.

    • Exit or Reverse on signal

    • After exit or reversal determine what the trend status is
      • If the exit was a reversal, then switch to REVERSAL cycle

     

     

     

     

    [*]RE-ENTRY

    • Weakness in trend and/or Retracement possible
      • Determine how big the retracement could possibly be, and wait for entry signal

      [*]Watch for Confirmation

      • Manage trade - Switch to "EXIT" cycle

      [*]Confirmation does NOT happens

      • Switch to "BAD ENTRY" cycle

     

     

     

    [*]REVERSAL

    • Look for confirmation of trend reversal

    • Trend reversal confirmed
      • Switch to GOOD ENTRY cycle

    • No reversal confirmation
      • Immediately exit or reverse back in original direction
      • Switch to BAD ENTRY cycle

     

     

     

    [*]GOOD ENTRY

    • Take the time to re-evaluate all your indicators, and the long and short price trend
    • Evaluate what the next phase of the trend could be, retracement, reversal, conflicted or consolidation.
    • Switch over to the exit cycle

     

     

     

    [*]BAD ENTRY or BAD RE-ENTRY

    • Look for signs of a conflicted market or price consolidation.
    • Price consolidation will mean a choppy, and sideways price range that can be confusing and difficult to trade. Evaluate the longer trend.
    • A conflicted market creates seemingly undefined trends, with no real direction and no discernible reason for price behavior. It may be a period of indecision. Check your state of mind, and ability to deal with the confusion.
    • Evaluate long trend
    • Long trend still the same
      • Switch to VIABLE, BUT LESS THAN OPTIMAL ENTRY cycle

      [*]Long trend has failed or shown a reversal signal

      • Reverse

     

     

     

    [*]GOOD EXIT

    • Evaluate short and long trend status
      • Trend still valid
        • Switch to RE-ENTRY cycle

     

     

     

    [*]PROFITABLE, BUT LESS THAN OPTIMAL EXIT

    • The assumption here is that you either made a mistake and mis-read market conditions, or the price overshot a normally legitimate exit signal.
    • I often see situations where the price continues strongly, but then retraces. If you chase the price, you can get caught entering an order exactly at the wrong point. If you wait to long, you can miss the opportunity. But once you get into the mentality of chasing price and feeling bad that you missed an opportunity, you can start trading the wrong part of the price cycle.
    • If price overshot the exit signal, it could mean that there will be a substantial retracement in the trend.

     

     

     

    [*]VIABLE, BUT LESS THAN OPTIMAL ENTRY

    • Determine how big the retracement (drawdown) could possibly be, and whether exiting and re-entering would in the original trend direction would minimize loss and maximize profit.
    • If you decide to stay in the trade and take the draw down before the potential change in the direction of your trade, make sure that support or resistance (depending upon a long or short trade) for the retracement is not broken. You must have criteria for how much retracement is valid before it becomes a trend reversal.
    • Decide ahead of time what your action plan is for another, second price move against your trade. If you can not come up with an action plan based on signals, and the signals meeting a certain criteria, then exit the trade and switch to STATE OF MIND check decision cycle.
    • Watch for confirmation of the trend moving in your favor, if that happens, switch to the EXIT cycle.
    • Trade move against you to the point where it's obvious that it was a bad entry. Count this as two bad entries. Switch to TWO BAD EXITS.

     

     

     

    [*]BAD EXIT

    • RESET

     

     

     

    [*]TWO or THREE BAD EXITS IN A ROW

    • Are you in the wrong State of Mind to be making good trading decisions?
    • Switch to the RESET decision cycle.

     

     

    [*]RESET

    • Start from the very beginning of the process. Re-evaluate the short and long term status and trends of price and all indicators.
    • Wait for a viable entry setup.

     

     

     

    [*]STATE OF MIND CHECK

    • Can you recover quickly from the bad state of mind? If not, consider exiting existing trades, and take time to recover.
    • Reset

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i developed something similar to this for myself but this goes into more detail, thanks a lot!!!

 

I tried keeping it as generic as possible. There could definitely be more detail. Plus I may have overlooked some things, or not made the decision flow perfect. I was trying to create a foundational document to build upon.

 

Ultimately, I'd like to have some logic defined for an automated system. If I can get the decision making defined well enough to convert to code, that would make the programing easier.

 

Thanks for commenting. If anyone has suggestions, examples, refinements, etc. feel free to make a contribution. Hopefully I can apply some details of my strategy to this framework and make another post.

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This post further defines degrees of a bad entry.

 

  • Enter Long at the Peak of a trend
  • Enter Long on the first move down of a down trend
  • Enter Long Part way down a down trend
  • Enter Long Almost at the bottom of a down trend
  • Enter Long at the very bottom of a down trend

 

Each of the above situations has a different degree of risk and disadvantage. Entering a Long order at the Peak as price is going up, is a much worse situation than entering long as price is going down, slightly before the real bottom of the down trend.

 

Real trading is more complicated than the above 5 possibilities. A long trend may have a retracement, then continue in a second phase of the long trend. You may not know whether the downward move in price is a retracement of an extended longer trend, or the first move down in a down trend.

 

The optimal situation is that a trader has a way to determine what is a retracement down in a long trend, or the first move down of a down trend. Both those situations can look and behave identically or almost identically. And the distinction between the two may not be apparent until after the change has already happened. Therefore you will be reacting well after the optimal window of opportunity has passed.

 

Deciding to suffer "draw down" from the worst situation compared to the next to best situation can have quite different consequences. Taking some draw down on a long entry just before a reversal up can turn out well. Taking draw down on a long entry that was entered at the first down move of a downtrend can turn out badly, especially if the second move down is fast and large. Then if you mistake the second move down for the bottom, and wait, then you could suffer a third move down.

 

In the optimal situation, a trader can determine the difference between a retracement before the second phase of an extended uptrend, and the first move down of a down trend. Let's assume the optimal situation. Even under the optimal situation, the trader must react very quickly, and you may be late unless you guess at what the next price move may be ahead of time and enter orders ahead of time.

 

So even under the optimal situation, a slight loss, and then a less than optimal re-entry may be unavoidable.

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